Morgan Stanley On Track? Depends On Who You Talk With

| About: Morgan Stanley (MS)

Summary

Morgan Stanley posted earnings that were 53 percent below that achieved last year at this time.

Over the past six years, James Gorman, Chairman and CEO of Morgan Stanley has attempted to introduce a new business model to the company and cut costs in the process.

The call from inside the bank seems to be, we will produce more cuts. After six years cutting costs, maybe the question should be, is this the right strategy?

Jonathan Pruzan, Chief Financial Officer of Morgan Stanley (NYSE: MS), is quoted as saying, "From a footprint and balance sheet perspective, we're getting to the right size. We've got to do better, but this is a good start."

The other news, Morgan Stanley profits are down 53 percent from one year ago.

What's most important?

Well, James Gorman, who became CEO of Morgan Stanley in January 2010 and Chairman in January 2012, has been trying to develop a new business model at the company since he took over. In fact, this, I believed, made Morgan Stanley one of the more interesting "big banks" during the recovery from the Great Recession. I have written about this many times.

Banking, however, is a very volatile industry these days, especially among the bigger members of the brand.

Glenn Schorr, a bank analyst with Evercore ISI, is quoted in the Wall Street Journal as saying "There are more predictable industries out there, for sure. Because the financial industry is very influenced by rates, credit spreads, by market activity levels, and by regulations. And those are hard to predict."

Does anyone remember the days when banking was boring… as it was supposed to be?

Mr. Gorman set out to reduce the size of the fixed income and commodities (FIC) unit "in order to achieve a better balance between volatile income streams from trading and stickier, annuity-like revenues from wealth and asset management."

Sounded promising.

The problem for Morgan Stanley as Ben Mclannahan writes in the Financial Times, "That effort was a failure" which Mr. Gorman "conceded in January, as he detailed more cuts to the FIC unit and pushed back the group's profitability target to the end of 2017."

Mr. Gorman's profitability target is Morgan Stanley's return on shareholders' equity. His objective is for Morgan Stanley to earn a return on shareholder's equity of 9 percent to 11 percent.

In the first quarter of 2016, Morgan Stanley earned an annualized 6.2 percent return on equity.

In the past two years, Mr. Gorman had seen the return on equity rise to 8.4 percent in 2015 and 8.7 percent in 2014 up from 0.2 percent in 2012.

CFO Pruzan said, "that the big round of FIC job cuts announced in December, combined with the shrinkage of the inventory within the business, were signs of a broad 'collective effort.'"

In other words, "the firm is resolute on its targets and clear that it will do more on costs if necessary," according to Guy Moszkowski, an analyst at Autonomous Research.

My concerns with Morgan Stanley at this point:

  • First, I am not sure that just cost cutting will produce the results that Mr. Gorman wants.
  • Second, the target return on equity Mr. Gorman hopes to achieve by the end of 2017 will just, roughly, cover the estimated marginal cost of capital of the bank, which should only make it an intermediate target.
  • Third, Mr. Gorman is now in his seventh year at the helm of Morgan Stanley and the question needs to be asked, "what kind of a grade should he be given for his efforts up to this point?"

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.