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20 Jan 2015 By Antony Currie

Morgan Stanley has rained on its own parade. The Wall Street firm was progressing nicely in the first nine months of 2014. But a dismal fourth quarter exposed cracks that boss James Gorman still needs to fix.

The investment bank’s earnings last quarter were a noisy affair that included a $1.4 billion tax gain and a $1.1 billion charge. Strip them out and net income applicable to shareholders for the period drops to $804 million from the reported $920 million, assuming a 30 percent tax rate. That’s an annualized return on equity of just 4.8 percent, compared with some 8.5 percent in the first three quarters of the year, based on Breakingviews adjustments.

The disappointing showing leaves Morgan Stanley’s ROE for 2014 at 7.5 percent. Gorman set a target of 9 percent a year ago and upped that to 10 percent on Tuesday. He won’t say how long it will take to get there, though, explaining unhelpfully that it’s “not a five-year target.”

Fixed income and commodities trading is the bank’s biggest problem. On a percentage basis, its 14 percent drop from 2013’s fourth quarter looks decent compared with some rivals. The trouble is that revenue is very low at $599 million, after eliminating accounting adjustments.

That’s not enough to produce decent returns. The firm’s relative weakness in government-bond trading is partly to blame, though results were better than in the final three months of 2013. More worrisome is that commodities traders had a rough time last quarter. Granted, the price of oil plummeted during the period, but Goldman Sachs on Friday reported that its commodities desk’s performance actually improved.

Morgan Stanley did fine elsewhere, though. In addition, the bank’s funding costs are falling, and it is getting more out of its growing retail bank.

Assuming bond and commodities trading picks up, Gorman might hit his ROE target as early as this year. And investors can always hope that the Federal Reserve helps out by allowing the firm to return more to shareholders after upcoming stress tests. Its Tier 1 equity ratio currently stands at 14.2 percent, after all, way above the 10 percent minimum watchdogs may expect. A regulatory boost to stock buybacks and dividends, though, is not something investors should count on.


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