Morgan Stanley's New York Headquaters
Photograph by Stan Honda—AFP/Getty Images
By Stephen Gandel
December 1, 2015

Morgan Stanley has spent the years since the financial crisis trying to shrink its riskiest business while still staying in the Wall Street game. It’s going to try again.

Morgan Stanley is reportedly planning to cut 25% of its fixed income operations, which includes commodities and bond trading. Other Wall Street firms have resized their bond trading in the past year, as business has been slower than expected. But Morgan Stanley’s pull back is larger than its rivals. The bank declined to comment.

Morgan Stanley (MS) has been trying to sell itself as the safest bank on Wall Street. It hasn’t quite worked out. In the third quarter, Morgan Stanley’s earnings dropped 42%, a steeper fall than its rivals. The bank’s fixed income trading division was one of the biggest sources of the drop. The firm’s revenue from trading bonds and commodities, like its earnings, were down by more than 40%. That was worse than rivals. Goldman Sachs’ (GS) fixed income revenue in the quarter was down around 35%. The same unit at JPMorgan Chase (JPM) saw a fall in revenue of just over 20%.

Fixed income trading has not been what it once was at any of the Wall Street firms since the financial crisis. And new regulations make it less profitable for banks to be in the bond trading business. This has increased fears about bond market liquidity. Morgan Stanley’s recently announced layoffs will only heighten those fears. Morgan Stanley says that it is making the cuts because it doesn’t think the business is coming back soon.

But the cuts are as much about a lack of revenue as it is about risk. CEO James Gorman has shifted Morgan Stanley toward wealth management, which produces recurring fees, and away from its trading and other risky Wall Street businesses. The shift has resulted in lower profitability for Morgan Stanley than Goldman. Since the financial crisis, Morgan Stanley’s return on equity, a key measure of profitability for financial firms, has bounced around in the single digits. Last quarter, it was just under 5%. Goldman’s ROE, on the other hand, has regularly topped 10% in the past few years.

The idea was that investors would be willing to pay up for Morgan Stanley’s diminished risk. But the strategy is not panning out. When the market sold off this summer, Morgan Stanley’s shares dropped 24%. Goldman’s shares, by contrast, were down 21%. So far this year, Morgan Stanley’s shares were down 12% before rising on Monday’s layoff news. Goldman’s shares are up 2% this year.

Morgan Stanley could have tried to make the case that its third quarter earnings was a blip. Instead, the layoffs show that bank executives still believe it has work to do when it comes to making the firm less volatile. The question is whether any Wall Street firm would really be able to insulate itself from the ups and downs of the market.

Morgan Stanley is not getting a premium for its move into less risky businesses. Indeed, its stock trades at around book value. Other financial firms that focus on wealth management, like Northern Trust and T. Rowe Price, trade at premiums to their book value. Northern Trust (NTRS) and T. Rowe (TROW) also have much higher ROEs than Morgan Stanley, at 11% and 24% respectively, showing that Morgan Stanley hasn’t maximized its shift into wealth management.

Morgan Stanley would need to cut back even more to match those rivals’ profits. Analyst Mike Mayo of CLSA says the cuts announced this week would boost Morgan Stanley’s profits by as much as $0.25 a share. That still only works out to an ROE of 8% by the end of next year. But if that is a less volatile 8%, investors may finally be willing to pay up for Morgan Stanley’s shares. If not, Morgan Stanley will have to cut again, and next time the cuts will likely be even more severe.

Editor’s note: A previous version of this story incorrectly stated that Morgan Stanley shares trade at a premium to its book value and that Goldman Sachs’ stock trades at a discount to its book value. In fact, Morgan Stanley stock trades at around book value and Goldman Sachs trades at a slight premium.

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