Morgan Stanley, Go; Goldman Sachs, No Go

| About: Morgan Stanley (MS)


Morgan Stanley has achieved a remarkable turnaround in the last five years under the leadership of James Gorman who apparently anticipated the changes that have come about in the market.

Goldman Sachs continues to work off of the same model it achieved so much success with when markets were more volatile and major contributions were made to earnings by traders.

Mr. Gorman's Morgan Stanley may not be as "sexy" as Goldman Sachs but is moving in a more positive direction and now has a market cap about equal to Goldman.

Recently, I have been griping a lot about leadership in the banking industry, especially at Bank of America (BAC) and Citigroup (C), but there is one bank CEO I thought was doing the right things since he took over and that leader is James Gorman at Morgan Stanley (MS).

Mr. Gorman took over the reins at Morgan Stanley in early 2010 and set about to change the focus of the organization. Liz Hoffman writes in the Wall Street Journal that Mr. Gorman “in 2010 took the reins of a firm humbled by the financial crisis and strategically adrift. His decision to de-emphasize trading and embrace wealth management has paid off, producing steady growth and winning over investors who had stayed away after repeated burns.”

Mr. Gorman is quoted in the article as saying “These changes don’t happen quickly, they happen over many years.” Mr. Gorman was faced with a turnaround situation and heavy regulatory scrutiny and faced up to the task.

It is not as if the bank has “made it” all the way back, but it is definitely moving in the right direction.

Morgan Stanley produced a return on shareholders' equity of 9.1 percent in the second quarter, continuing the slow but steady progress that Mr. Gorman aimed at once he took over. In 2010, Morgan Stanley posted a ROE that was just barely positive. Returns have increased steadily since that time.

It should be noted that Mr. Gorman’s target range for the bank’s return on equity is only in the 9.0 percent to 11.0 percent range. He is very modest with this goal. One reason is that his efforts to enhance the safety of the institution is to reduce financial leverage to the point that it will free him and Morgan Stanley from excessive regulatory oversight, something he felt when he took over leadership of the institution.

At the end of the second quarter, Morgan Stanley boasted a 16.6 percent Tier I capital ratio, the highest amongst the largest six domestically chartered US financial institutions.

With such a robust capital position, Morgan Stanley will not be able to produce the returns around 15 percent or more that commercial banks produced before the financial collapse that began in the fall of 2007.

As I will document further below, Mr. Gorman has looked over the financial scene and restructured Morgan Stanley to operate in an era of modest economic growth, low inflation, and low market volatility. His perception of what the economic scene of the post-Great Recession recovery has been much closer to reality than many of his competitors.

The Goldman Sachs Group, Inc. (GS) has done just the opposite. Goldman, under the leadership of Lloyd Blankfein, has retained the business model that had served it so well in the past.

Liz Hoffman writes in the Wall Street Journal:

“Goldman cited weakness in nearly every major fixed-income product it sells, from interest-rate derivatives to credit instruments.

Goldman’s trading business relies more on swashbuckling stock pickers than peers, a strategy that paid off in years past but now puts the bank on the wrong side of shifts in the money-management industry. As more assets move from actively managed funds to passive ones, trillion-dollar pools trade less frequently and generally need fewer services. “


“Goldman’s stable of hedge-fund clients are grappling with poor performance and outflows.

That has led to less demand for Goldman’s specialty: exotic trading products that allow investors to make one-of-a-kind bets on asset prices.“

Goldman’s trading revenue fell 17 percent from a year ago, “capping the worst six-month start of the year under Mr. Blankfein’s 11-year tenure at the leader of the company.

The fixed-income trading business at Goldman was down 40 percent year over year!

The return on shareholders' equity at Goldman came in at 8.7 percent. Goldman’s ROE reached a current peak in the 2013-2015 period of just over 10.0 percent and has been falling since as market volatility has fallen. That’s what happens when you rely on market volatility to drive your performance.

Returning to Morgan Stanley and its stellar performance in the second quarter, net income increased by more than 11 percent. In terms of wealth management, the major focus of Mr. Gorman’s restructuring, the income from this area rose by 23 percent year over year, and client assets rose by $200 million to reach $2.2 trillion. Wealth management’s loans rose by 21 percent to reach 73.2 billion. Morgan Stanley’s investment banking fees jumped by 28 percent.

Morgan Stanley still does trading but has reduced the emphasis given that particular area. And, last year, the company reduced the number of fixed income traders in the company by 25 percent and also slashed the capital allocated to this sector. Still, trading income came in at $1.2 billion “outperforming Goldman for the second straight quarter thanks to strong trading in currencies and corporate debt.”

Mr. Gorman’s goal for this area, even though it has been reduced in importance in the company, is $1 billion in revenue, a target that Morgan Stanley traders have exceed for the five straight quarters since the goal was set last year.

“Including Morgan Stanley’s stock traders, the firm reported trading income for the quarter of $3.2 billion compared with Goldman’s $3.1 billion.

During the first half, Morgan Stanley’s overall trading revenue surpassed Goldman’s for the first time since at least the financial crisis.

Part of the story is that Goldman has stumbled. Its traders, once dominant on Wall Street, are struggling to find their footing amid sweeping market changes since the crisis.”

Morgan Stanley under the leadership of James Gorman, early on, made the adjustment to the new market environment, emphasizing steady, duller activities. So far, Mr. Gorman has executed his plan well within this new era, and his results continue to show positive results.

Turnarounds take time, but by the seventh year of new leadership, there should be positive results and indications that the direction of change will continue in that positive direction.

Oh, by the way, Ms. Hoffman writes that in 2009, Morgan Stanley, the company, was worth $50 billion less than Goldman Sachs. At the close of the market yesterday, Morgan Stanley’s market value was $86.2 billion vs. a market value of $87.7 billion for Goldman Sachs.

I give Morgan Stanley a go, and I give Goldman Sachs a no go.

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.

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Tagged: , Investment Brokerage - National, Earnings
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