By Justin Baer
After years of ratcheting back trading operations in favor of
more stable businesses, Morgan Stanley is quietly plotting a
comeback.
The Wall Street firm is pushing for more fixed-income trading
business, where it lost billions of dollars during the crisis and
historically suffered from bad timing. Now, the firm hopes adding
market share in the division, which trades bonds, swaps, currencies
and other debt securities, could help Chairman and Chief Executive
James Gorman hit long-held profitability targets. But the effort
could also turn off analysts and investors who have lauded the
firm's recent embrace of less-risky activities.
Since Morgan Stanley nearly collapsed in late 2008, the firm has
diverged from chief rival Goldman Sachs Group Inc., which largely
has stuck to its knitting in trading. Morgan Stanley's shift toward
wealth management over sometimes volatile trading businesses has
won plaudits from regulators and shareholders--its stock price has
outperformed Goldman's in the last two years despite Morgan
Stanley's lagging profitability.
With U.S. interest rates expected to rise and Morgan Stanley's
own credit rating boosted two notches last month by Moody's
Investors Service, Mr. Gorman and his top lieutenants see an
opportunity to boost the firm's share of the some $100 billion in
annual Wall Street revenue tied to fixed-income trading, people
familiar with the matter said.
In recent weeks, Morgan Stanley has been soliciting more
fixed-income business and pitching more trading ideas to clients
like BlackRock Inc., the giant fund-management firm, the people
said. The firm believes it could generate several billion dollars
in additional revenue over time in its debt-trading arm, which
produced $3.8 billion in 2014.
Morgan Stanley thinks it can rack up more business trading bonds
and other debt securities without enlarging its balance sheet. The
firm expects to benefit from the ratings upgrade as well as the
gradual retreats from some of its peers. Adding business from
existing clients--especially large money managers--can help speed
up the pace of securities cycling in and out of the firm's trading
inventories, the people said, while keeping a lid on the balance
sheet. Some analysts are skeptical.
A decision to dive deeper into bond trading is potentially
significant as big banks deal with regulators who have judged
certain trading businesses harshly since the crisis, often
requiring that banks set aside more capital to guard against
adverse bets.
Fixed-income trading is one of Wall Street's most volatile--and
potentially lucrative--businesses. While it has been out of favor
in recent years, volatility in parts of the bond market and exits
by other players have prompted some analysts to wonder whether
remaining Wall Street firms could see an expanded role in coming
years.
Morgan Stanley's past only underlines the fleeting nature of
many strategic decisions on Wall Street; banks have repeatedly
withdrawn from certain activities only to recommit when the
business booms--and rivals that once ceded market share can roar
back with the right investments.
The upgrade from Moody's also potentially makes the firm a more
attractive trading partner, because clients see a higher-rated firm
as less likely to default on an agreement.
"The firm's strategy in fixed income remains unchanged, as does
our strategy for the firm. The metric we are focused on continues
to be return on equity," a Morgan Stanley spokesman said in a
statement.
Shedding assets from Morgan Stanley's fixed-income business has
been a central plank in Mr. Gorman's turnaround plan. A smaller
balance sheet has freed up capital the firm has begun to return to
shareholders through stock buybacks and bigger dividends, which in
turn has helped lift returns. Risk-weighted assets within the
bond-trading arm slipped below $180 billion this year, meeting Mr.
Gorman's goal. Those assets totaled $370 billion in 2011.
The renewed push in fixed income comes as the firm begins what
its executives hope is a final ascent toward a long-elusive goal:
producing an annual return on equity of more than 10%. Morgan
Stanley hit that target in the first quarter when its fixed-income
business churned out a $1.9 billion quarter. It was the division's
best performance since the first quarter of 2012--the last full
period before Moody's moved to downgrade the firm's ratings.
Rivals and former Morgan Stanley executives have questioned
privately how any Wall Street firm could produce double-digit
returns consistently without a bigger fixed-income trading
division.
The firm has identified the rates business, which traditionally
generates more revenue than other parts of fixed income, as having
the biggest potential, the people said. Rates traders buy and sell
government bonds and interest-rate swaps, or derivatives in which
one investor trades one stream of interest payments for another,
allowing the buyer to place a bet on or hedge against a rate's
direction.
Morgan Stanley's debt-trading business has seesawed violently
several times over the past decade, both in profits and in the
firm's commitment.
The firm had dialed up its riskier trading activities right
before the financial crisis, with disastrous results. Then, when
the debt markets sprung to life in 2009, leading to massive profits
at rivals such as Goldman Sachs and J.P. Morgan Chase & Co.,
Morgan Stanley's traders sat on the sidelines. The firm reversed
course again the following year, but the buildout ended abruptly
amid a flurry of new regulations, slumping volumes and a 2012
ratings downgrade.
As recently as last year, the firm was eliminating jobs from its
rates and foreign-exchange trading desks. While the fixed-income
division's head count has been flat of late, the firm has been
hiring selectively.
Debt markets have flashed signs of emerging from a long stretch
of meager client activity. In addition, Morgan Stanley sees an
opening as traditional European fixed-income heavyweights such as
Barclays PLC and Deutsche Bank AG have signaled they would shrink
their assets.
"We're also seeing, I would say, significant disruption to some
of the European business models," Morgan Stanley finance chief
Jonathan Pruzan said during an investor conference this month. "So
I think, as people redefine who they want to be and what they are,
there's going to be some market share up for grabs, so we do think
that that's going to be a longer-term opportunity."
Moody's Investors Service raised its debt rating on Morgan
Stanley by two notches in late May, reversing a 2012 downgrade that
had revived concerns about the Wall Street firm's prospects in a
postfinancial crisis era of smaller bank profits and more
regulation.
Wall Street firms' ratings matter to many large investors,
especially those that manage money for pension funds. If a fund
manager enters a derivatives contract with a bank--or any
counterparty--under duress, it risks not being able to collect on
its side of the trade.
At the June 9 investor presentation, Mr. Pruzan said the firm
"had gotten some good feedback from clients" related to the
two-notch Moody's upgrade. Executives at BlackRock, the world's
biggest money manager, have recently indicated they want to direct
more fixed-income trading business Morgan Stanley's way, people
familiar with the matter said.
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