Morgan Stanley is set to make deep cuts to a key trading division — and investors are trying to figure out what’s going on.
News broke last week that the banking titan would cut its fixed income, currencies, and commodities (FICC) staff by a quarter before the end of the year.
Bond trading revenue was down 42% year-on-year at Morgan Stanley in the third quarter. FICC revenue was weak across Wall Street, but the Morgan Stanley decline was especially pronounced.
UBS analyst Brennan Hawken thinks the FICC cut could be good for Morgan Stanley — he estimates it could boost the firm’s return on equity by as much as 125 basis points.
But there are a few big questions on investors’ minds, according to Hawken. He said he hopes the questions will be answered in January, when the firm reports fourth quarter earnings and is expected to provide a strategic update.
Hawken walked us through some of the important questions.
Will Morgan Stanley be left chasing after its competitors if FICC business picks up again?
Some investors worry that Morgan Stanley will be unprepared if bond trading activity starts to pick up again after it cuts down its FICC division.
It wouldn’t be the first time the firm has had to play catch-up. In the late 1990s and early 2000s, Morgan Stanley sat out while most of Wall Street charged into the fixed income business. It was not until after John Mack replaced Phil Purcell as CEO in 2005 that Morgan Stanley finally joined the FICC party and loaded its balance sheet up with risk.
Then, the financial crisis hit and Morgan Stanley had to pull back from the fixed income business. Most banks began taking down positions and laying off staff, but those that did stay in the game, namely JPMorgan and Goldman Sachs, profited hugely during a sharp rebound in activity.
Seeing that, Morgan Stanley re-invested in the FICC space in late 2009 and early 2010, again hiring new bond traders to rebuild the business — just as the rebound proved to be short-lived.
Now the firm is planning to cut back in FICC again, and some investors are worried that history could repeat itself.
What about the Ted Pick factor?
Another question on investors’ minds, according to Hawken, is what Ted Pick’s impact will be on the trading division.
Edward “Ted” Pick was promoted to head of the entire trading division in October. Previously, he had been running equities trading.
Pick is thought to be smart, shrewd, and hard nosed.
“He’s very well-respected but he is a numbers guy,” Hawken said.
He’s viewed as a change agent for Morgan Stanley — and investors will want to know what changes he has in mind.
What does a 25% headcount reduction really mean?
The FICC cutback, which was originally reported by Bloomberg’s Ambereen Choudhury, Michael J. Moore and Hugh Son, is expected to amount to about 25% of headcount.
But as Hawken pointed out, it doesn’t really mean anything. It doesn’t automatically translate into a 25% reduction in costs or capital or revenue.
“We all know that revenue will naturally go down, costs should go down, and capital should go down, but we want to know to what extent that will happen and what the timeline is,” Hawken said.
Where will the capital be redeployed?
The other big question is whether the capital that is currently being used up by the fixed income business will be redeployed, and if so, where.
In a note on Monday, Hawken estimated that a one-quarter reduction in FICC would add about 50 basis points to the firm’s return on equity (ROE) if the capital is returned to shareholders. It would add 125 basis points if it’s rolled into the equities or investment-banking divisions. If it’s transferred to the wealth management business, Hawken said, the ROE bump would be even higher.
We asked Hawken which option he thought would be most likely.
“Personally, I think the most likely is in equities and banking,” Hawken said.
He noted that prime brokerage is one of the more capital-intensive parts of the equities business, and other firms are starting to cut back there as a result of capital requirements.
“Given that Ted Pick comes from equities, I think that that’s where he’s going to want to feed.”
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