IN A speech to Morgan Stanley’s staff during the market turmoil of 2008, John Mack, the firm’s street-fighting boss, wondered aloud: “How do you get through chaos?” Wall Street’s most blue-blooded firm survived, bloodied, with government help and some timely investments from Asia. The question facing Mr Mack’s successor as chief executive, James Gorman (pictured), an urbane Australian, is equally vexing: how should the 75-year-old firm be reshaped so that it can prosper in a post-crisis world?
The answer lies partly in undoing much of the firm’s pre-crisis expansion under Mr Mack into mortgages and other risky, leveraged assets. The balance-sheet has shrunk by about 20%. Proprietary-trading desks have been closed or are being spun off, as are hedge funds. A push into more stable, and capital-light, wealth management and retail brokerage was made through the opportunistic purchase of 51% of Smith Barney from Citigroup. New people have been brought in to run the firm’s key divisions.
It is the biggest voluntary overhaul of any big American financial firm since 2008 (Citi was forced by regulators to restructure). It sets Morgan Stanley in contrast with its archrival, Goldman Sachs, which doesn’t seem keen to change at all.
Executives insist that this does not presage a new Morgan Stanley but merely a rebalancing towards less volatile, client-facing businesses, many of which, such as merger advice and securities underwriting, were the firm’s bread and butter before it contracted Goldman-envy. The firm has “cut off” the bits that made aggressive bets with its own capital, says Mr Gorman. Suspect units included a single mortgage desk that lost $9.6 billion. His mantra is “originate, distribute and manage capital”, not punt your own.
The ride is proving bumpy. After a good first half of the year, the firm made profits of only $313m from continuing operations in the third quarter, down from almost $1 billion a year earlier. Particularly disappointing was the institutional-securities (ie, investment banking and trading) division, the engine of the group. Its revenues slumped to their lowest since early 2009. An insider jokes that Morgan’s underperformance relative to Goldman is a public-relations ploy to ensure that the firm remains more popular than its rival. “With the lion’s share of the business being restructured, and new faces at the top, the outlook is unusually uncertain,” says Michael Mayo, an analyst at CLSA, a broker.
The firm is in a strong position in retail brokerage. The Smith Barney deal catapulted it to the top spot, with 18,000 brokers and $1.6 trillion in client assets. In a business where scale is important, only two competitors come close: Bank of America/Merrill Lynch and Wells Fargo. “We’re the prettiest girl at the dance,” boasts Mr Gorman. Morgan Stanley Smith Barney (MSSB) not only provides a huge distribution platform—for instance, the firm recently led a stock offering for General Motors—but is also a useful source of deposits.
The division has not been without problems. A lot of leading performers left after the merger, though the rate of departures has since fallen. Fear of losing more talent has kept the brokers’ compensation ratio at 60%, and the firm’s overall ratio at an uncomfortably high 54%, well above Goldman’s. But there is a lot of money to be made if the firm can make its brand as trusted on Main Street as on Wall Street.
Morgan Stanley’s reputation among blue-chip companies has remained strong, despite its near-death experience and earlier turmoil, such as the controversial merger with Dean Witter in 1997 and subsequent palace coup in 2005. Morgan heads the global league table for announced mergers and acquisitions this year and is in the top two in equities. It is popular with governments looking to sell shares: recent deals it jointly led include Petrobras and Agricultural Bank of China, as well as GM. “It would take a nuclear weapon to sink a brand as strong as theirs in traditional investment banking,” says a senior executive at a rival firm.
Morgan Stanley is, by contrast, an also-ran in fixed income, a crucial area these days that includes credit, commodities and rates. With 6% of the market, it is less than half the size of the biggest “flow monster”, Goldman. That matters not least because, as Morgan Stanley’s own analysts point out, the bigger you are in fixed income, the less volatile your returns. The firm is trying to push its share to 8% but Colm Kelleher, who runs sales and trading, acknowledges the scale of the task: “You don’t go from where we are now to being a top three counterparty in a quarter or two.”
In asset management, the smallest of the firm’s three main businesses, it will take years to reach its goal of becoming an “industry leader”, even if all goes to plan. With $273 billion of client money Morgan is a minnow—its eight largest rivals all manage more than $1 trillion. Long run as a collection of silos, asset management has scraped a profit in just two of the past 11 quarters. To jump-start the division, Mr Gorman has hired Greg Fleming, a former president of Merrill Lynch, whose past achievements include helping to sell his old firm to Bank of America for far more than anyone else would have paid.
Mr Gorman himself is a breath of fresh air. Mr Mack was the investment banker’s investment banker: a charismatic former bond salesman driven by instinct as well as analysis. By comparison, his successor, a former consultant known for his strategic flair, is “positively Cartesian”, as a colleague puts it (though sufficiently down-to-earth to be taking boxing lessons). “If John was our wartime leader, James is our peacetime builder,” says Mr Kelleher. Some worry that Mr Mack, now chairman, will meddle, creating tension at the top. He and Mr Gorman profess to get on well, however. There are no signs that Mr Mack, who now spends most of his time with clients, is interfering with strategy.
He may have more to say if the share price does not liven up over the next year or so. The firm trades at 20% below its book value, compared with 25% above for Goldman. Analysts want to see clear financial targets. But Mr Gorman will only commit himself to a goal of a “high-teens” return on equity “in normal markets”. The target of a 20% pre-tax margin at MSSB by 2012 has been quietly dropped.
Another worry is that the increased emphasis on the retail business will, over time, sap the cachet of the more venerable institutional business. “If [investment banking] is no longer your one big thing, it can become harder to attract the best people. And it can be insidious, like diabetes,” says a former senior Morgan Stanley man. The firm also needs to work harder to keep big clients sweet. Some have complained that it is “extremely complicated to do business with”, admits Mr Gorman. To fix that, he has hired a batch of experienced relationship managers, including Merrill Lynch’s Kevin Dunleavy, who has an enviable list of hedge-fund contacts.
The problems have at least been identified. Insiders talk of a new-found scrappiness: “a determination that the firm be more than just a survivor,” as Ted Pick, co-head of equities, puts it. The chief executive is leading from the front when it comes to wooing clients: he has met more than 400 since taking over in January.
And when it comes to managing risk and allocating capital according to risk-adjusted returns, not crude revenues, lessons appear to have been learned. After reeling off numerous initiatives in these areas, Mr Kelleher suggests that the recent crisis will prove to be for Morgan Stanley what the 1994 bond market blow-up was for Goldman: an event so traumatic that it leads to a permanently increased attunement to risk.
“In the future we’ll show more discipline in defining the sandboxes we play in,” says Mr Gorman. If he keeps to that promise, the firm that was founded during the Great Depression through a spin-off from J.P. Morgan might one day look back on the Great Recession as a time of rebirth, not just pain.
