Morgan Stanley Chief Gorman's Overhaul Pays Off -- WSJ

By FeaturesDow Jones Newswires

This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (January 19, 2018).

Morgan Stanley on Thursday reported fourth-quarter results that highlighted the fruits of Chief Executive James Gorman's efforts to make the firm a simpler and steadier earner.

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Quarterly profit rose 14%, excluding a tax charge, as the firm's retail brokers and investment bankers compensated for a decline in trading that has been widely felt across Wall Street.

The firm earned 84 cents a share on revenue of $9.5 billion, which was up 5% from a year ago. Analysts had expected 77 cents a share, excluding the impact of a one-time, $990 million charge related to the new tax law. Net income of $1.7 billion beat analyst expectations.

Including the tax charge, which was lower than Morgan Stanley had indicated, the firm earned $686 million, or 29 cents per share.

Morgan Stanley, the smallest of the big six U.S. banks, was the last to report earnings for a quarter that was muddied by tax charges and marked by continued gloom for trading operations and strength in consumer and investment banking.

Eight years into his tenure, Mr. Gorman has now achieved most of the numerical targets he set out in early 2016. Morgan Stanley has cut more than $1 billion in fixed expenses, cleaned up trouble spots like fixed-income trading, improved the profitability of its giant retail brokerage, and hit its goal of a 9% return on equity.

Mr. Gorman's next challenge is to boost that return -- which measures how well a company invests shareholders' money -- into the low teens. This is a level that investors typically demand given the risk that comes with owning bank stocks.

On Thursday, Mr. Gorman set a new goal of 10% to 13% return on equity, without specifying a time frame. A lower tax rate will help, as will the roll-off in 2019 of some expensive contracts with brokers who joined in the acquisition of Smith Barney.

But future gains will likely be tougher than those achieved to date, as Mr. Gorman has already pulled obvious levers such as cutting expenses and reducing risky trading assets. What is more, Morgan Stanley's wealth management and investment banking business are riding a bull stock market that likely won't last forever.

Quarterly revenues in fixed-income trading, which Morgan Stanley sharply cut two years ago after repeated blunders, fell 45% in the quarter. Peers reported declines of between 14% and 50% in that business as few market catalysts spurred clients to trade.

"Very, very quiet," CFO Jonathan Pruzan said of the quarter. He said he was "cautiously optimistic" that the backdrop would improve.

Morgan Stanley held its ground in stock trading, where it is Wall Street's leader. Revenues rose 2% in that business.

One area of weakness: Merger advisory revenues fell 6%, widening the deficit between it and Goldman, which on Wednesday posted a 9% rise in that business to cement its role as Wall Street's top M&A shop. More than $1.1 billion in trailing-year revenue now separates them, the widest gap in two years.

Morgan Stanley's X-Factor, though, is increasingly its giant retail brokerage, which oversees $2.4 trillion for some 3.5 million households. That unit's revenue rose 10%, while lower expenses lifted its profit margin -- once in the high single digits -- 1 percentage point to 26%. Mr. Gorman set a new upper goal of 28%.

Broker attrition and hiring, which are both expensive, have fallen, Mr. Pruzan said. Morgan Stanley and rivals including Bank of America Corp.'s Merrill Lynch unit and UBS Group AG have effectively called a truce on a yearslong poaching war, a move that ruffled some brokers but is likely to reduce costs across the industry.

Morgan Stanley's retail brokerage gets a growing portion of its revenue from steady fees that are assessed as a percentage of client portfolios, rather than commissions on trades. As the stock market marches higher, Morgan Stanley is guaranteed profits on those accounts whether clients trade or not.

On 99% of days last year, the brokerage brought in between $50 million and $80 million in revenue. More than three-quarters of this came from steady sources such as management fees and interest on client loans.

Morgan Stanley kept a lid on expenses, making good on a 2016 promise to cut $1 billion in costs, assuming flat revenue. Dubbed Project Streamline, the effort's roughly 200 initiatives included lowering bankers' and traders' pay, shifting workers to cheaper locations like Baltimore and combining data centers.

Regulatory changes from Washington, including decreasing the level of capital banks must hold, could improve returns further by allowing the firm to increase its dividends or buybacks.

"We think we're overcapitalized by several billion dollars," Mr. Gorman said. "If we got some change that allowed us to take action on that, in the absence of finding better ways to invest it or better things to buy, we believe in being very shareholder friendly on this stuff."

Write to Liz Hoffman at liz.hoffman@wsj.com

(END) Dow Jones Newswires

January 19, 2018 02:47 ET (07:47 GMT)

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