Morgan Stanley CEO James Gorman has guided the firm in a more cautious direction in the wake of the financial crisis.CHESTER HIGGINGS JR./The New York Times
At a conference in New York earlier this month, James Gorman, the chief executive of Morgan Stanley, tried to explain to an audience of non-bankers the dramatic changes at his firm. He chose a nautical metaphor.
The firm has an "engine room," he said, the areas that rev up when markets are racing. But it has added a major element in recent years.
"It's what I call the ballast," said Mr. Gorman. "It gives us stability in the storms."
After nearly sinking during the financial crisis, Morgan Stanley has gone much further than any of its peers in reshaping its business to navigate new waters. Unlike its rival Goldman Sachs Group Inc., Morgan Stanley made a deliberate choice to become more boring. It bulked up its retail brokerage arm – the ballast – and reduced its exposure to risky trades.
Now it is close to declaring an early victory. In its results for the first quarter announced in April, the firm hit a sweet spot: strong annual growth in profit from its investment banking businesses, such as trading and advising on deals, combined well with a similarly healthy jump in profit from its wealth management unit, which now represents almost half of the firm's total revenues.
As mergers and acquisitions surge worldwide, Morgan Stanley has seized a primary role. So far this year, it is in first place among banks for arranging such deals globally, according to Bloomberg data.
"They have made very radical changes in strategic direction, more so than anybody else," said Charles Peabody of Portales Partners in New York, a research firm focusing on financial services. "They are moving in the right direction, no question, but they've got a ways to go."
In particular, profit margins are not yet at the levels that Mr. Gorman has targeted. A key measure of bank profitability is return on equity – in effect, how much profit they generate with shareholders' capital. In the most recent quarter, Morgan Stanley had a return on equity of 8.9 per cent, compared with 10.9 per cent for Goldman Sachs.
But several analysts believe Morgan Stanley's new two-pronged strategy – the ballast plus the engine room – is well-suited to today's environment of heavy regulation, soaring stock markets and tepid economic recovery. Over the past year, its shares are up nearly 20 per cent.
Mr. Gorman "will be beatified in 2015 as the leader who saved Morgan Stanley," predicted Brad Hintz, a senior financial analyst at Sanford Bernstein & Co. But, he added, "I worry about 2016 and beyond."
A former consultant at McKinsey & Co., Mr. Gorman, 55, joined Morgan Stanley's retail brokerage unit in 2006 and became chief executive in 2010. The Australian executive has a forthright way of talking about the financial crisis and a dry sense of humour. At the conference in New York earlier this month, his interviewer said, "The country is not in love with bankers." Mr. Gorman paused and said, "I did not know that."
He added that banks had employed "frankly appalling underwriting standards" in the runup to the meltdown and that his firm was "eternally grateful" for the capital infusion it received from the U.S. government.
A major part of Mr. Gorman's vision for Morgan Stanley involved building up the business of providing investments and services to wealthy individuals via brokers. Last year, Morgan Stanley completed a deal with Citigroup Inc. to buy out the latter's entire share in their joint wealth management business, which included the former Smith Barney retail brokerage.
That means Morgan Stanley now has sole control of a giant retail footprint that includes more than 16,000 advisers managing nearly $2-trillion (U.S.) in customer assets. Historically, wealth management is a less volatile business than investment banking. And the customer cash it brings can be deployed to fund other loans across the firm, whether individual mortgages or corporate financing.
To adapt to the new regulatory environment, Morgan Stanley has jettisoned the trading desks that made bets for the firm's own profit. It's also looking to offload two units involved in the transportation and storage of oil as U.S. regulators scrutinize banks' involvement in such areas.
Most significantly, Mr. Gorman has downsized the firm's unit that trades bonds, currencies and commodities, a traditional profit driver for investment banks. He is reducing the assets – weighted by risk – deployed in the unit to $200-billion, cutting them in half over a four-year period. The bond-trading business has delivered uneven performance in recent years and the firm is now focusing on improving profit margins rather than expanding revenues.
Some analysts are skeptical, however, that Morgan Stanley can scale back the size of the business without causing long-term damage to it. (In response, a Morgan Stanley spokesman pointed to the firm's most recent quarterly results, which showed an annual increase in fixed-income trading profit that outstripped its peers.)
"We happen to think we've got a business model which meets the best of both worlds," said Mr. Gorman in May. "Time will prove whether that's the case."