By Justin Baer And Peter Rudegeair
Morgan Stanley is riding a nascent revival in its debt-trading
arm. It just doesn't want the unit to ride too high.
The firm won plaudits from investors in recent years for its
strategy turning attention and capital away from the unit that had
consumed too much of both in Wall Street's postcrisis era.
Now, Morgan Stanley Chairman and Chief Executive James Gorman
must find a delicate balance between seizing opportunities that may
arise as European rivals retreat, while staying true to the
strategic path that has rallied its stock price.
Revenue from the unit, which includes fixed-income, currency and
commodities trading, jumped 21% in the first half of 2015 to $3.38
billion, the fastest start for the division since 2011. The
results, coupled with strong gains in its stock-trading business,
helped boost Morgan Stanley's second-quarter profit above analysts'
estimates.
The fixed-income unit's improvement also has helped put the firm
on track this year to meeting Mr. Gorman's target for annual return
on equity of 10% or better.
On a conference call with analysts, Mr. Gorman said Monday
"there's potential for, over a period of time, share gain for our
business." But on that same call, he was quick to point out that
Morgan Stanley's strategy hadn't changed.
To meet new regulatory requirements and boost returns, the firm
has shed more than $200 billion in risk-weighted assets from its
fixed-income business since the crisis. The most recent total of
$157 billion remains below the firm's target of $180 billion.
"It may go higher from here, which is a change, but this is
nonetheless far below" the peak four years ago, wrote Mike Mayo, a
CLSA analyst who raised his target price for Morgan Stanley shares
Monday.
The New York-based bank reported a profit of $1.81 billion, or
85 cents a share, for the second quarter.
That fell short of the $1.9 billion it reported for the same
period of 2014, when the firm enjoyed a tax benefit. Per-share
earnings, though, beat analysts' average estimate of 74 cents.
Revenue rose 13% to $9.74 billion. Excluding accounting
adjustments, the total also beat Wall Street expectations.
Overall, Morgan Stanley's trading revenue totaled $3.5 billion
in the quarter, up 32% from a year earlier. At rival Goldman Sachs
Group Inc., a firm more associated with trading prowess,
second-quarter trading revenue fell 6% to $3.6 billion, leading to
a narrow trading gap of about $97 million between the two
firms.
Morgan Stanley "won the trading game this quarter," said Jeff
Harte, an analyst with Sandler O'Neill + Partners LP.
The firm enjoyed another big quarter in stock trading, long the
stronger sibling compared with fixed income. Stock-trading revenue
surged 28% to $2.34 billion. Unlike at the fixed-income unit,
Morgan Stanley's stock traders also increased revenue from a strong
first quarter.
Morgan Stanley may have some room to run in bonds, a unit that
gave the firm fits during the financial crisis under Mr. Gorman's
predecessor, John Mack.
"This was a very solid quarter, not a sensational quarter," Mr.
Gorman told analysts Monday. While "the strategy is not
changing...it doesn't mean that we won't pick up share. And it
doesn't mean that as these markets continue to grow off relatively
low volumes there won't be more opportunity for us."
In an interview, Chief Financial Officer Jonathan Pruzan said
that trading government bonds and other interest-rate-sensitive
securities accounted for much of the increase during the
quarter.
Write to Peter Rudegeair at peter.rudegeair@wsj.com
The firm's overall return on equity, a commonly used measure of
bank profitability that Mr. Gorman has flagged as an important
metric, was 9.1% compared with 10.7% in the second quarter a year
earlier, excluding an accounting adjustment.
For the first half, Morgan Stanley's ROE stood at 11.3% on an
annualized basis, reflecting a steady climb since Mr. Gorman, a
onetime McKinsey & Co. consultant and Merrill Lynch & Co.
executive was promoted to become Morgan Stanley CEO in 2010.
After the financial crisis, Morgan Stanley's trading troubles
led it to pare its fixed-income unit and put more emphasis on the
nearly 16,000 brokers in its wealth-management unit. That division
also performed strongly in the second quarter, with profit before
taxes rising 16% to $885 million.
The division's profit margin before taxes was 23%, within the
22%-to-25% range executives are targeting for the year.
While the retail-brokerage business is growing steadily, the
fixed-income division is more of a wild card, since it could boost
revenue further, depending on market conditions and continuing
regulatory pressures.
"It's super-hard to navigate," warns Evercore ISI analyst Glenn
Schorr. "You can't shrink assets and have a commitment to having
10% returns and think it will be easy to grow revenue and market
share."
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