James Gorman must shine or resign in 2013. The Morgan Stanley chief executive presided over another poor quarter in the three months to December. Granted, earnings beat expectations, hitting $894 million after stripping out an accounting hit from improvements in the value of its own liabilities. And, there are encouraging signs, which combined sent the stock soaring as much as eight per cent. But investors have seen these before and not yet reaped the benefit.
The highlight was Morgan Stanley’s global wealth management unit. Its pre-tax margin jumped to 17 per cent, having bobbed up and down around 11 per cent for much of the past few years. Taking an extra 14 per cent stake in the retail brokerage joint venture from Citigroup helped earnings, as did a slightly lower compensation bill. Most restructuring and integration charges are also now in the past. With another 35 per cent left to buy from Citi by next year, earnings ought to get even better — as should returns, since the bank already holds capital against the entire business.
That performance helped offset a slow quarter in commodities trading, which dragged down Morgan Stanley’s FICC unit. But the firm’s overall annualised return on equity only amounted to around six per cent. And, that relied on a $155 million tax break which reduced its effective tax rate to just 11 per cent. Stripping that out would leave ROE languishing below five per cent.
Recent moves to cut costs should help. At 44 per cent of revenue for 2012 as a whole, adjusted compensation for the investment bank was nine percentage points lower than 2011. But pay is still taking a bigger chunk of revenue than the roughly 38 per cent at rival Goldman Sachs. Morgan Stanley’s ratio ought to drop more this year, as the bank reduced headcount by 6,000 over the past 12 months.
Even that may not be enough. The firm’s overall costs were 85 per cent of adjusted revenue last year, while Goldman’s stood at 67 per cent of the top line. Gorman reckons his bank can boost returns in FICC by reducing risk-weighted assets and capital but he has yet to make it happen. Gorman has done a lot of restructuring in his three years in the corner office and that should bring better times. But if it doesn’t yield a return on equity approaching 10 per cent in the next 12 months or so, it will be time for him to throw in the towel.