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21 July 2011 By Antony Currie

Few things are sweeter for Morgan Stanley than beating Goldman Sachs. Not only did the bank report higher revenue and core earnings than its arch-rival but the fixed income traders at the firm run by James Gorman also outdueled counterparts at Lloyd Blankfein’s shop. Special items aside, that trading feat hasn’t happened in almost a decade. As satisfying as the win may be, however, it’s still a bit of a distraction.
That’s not to undermine the importance of Morgan Stanley repairing its fixed income, currency and commodities business. It’s the only investment bank so far to report a quarterly increase in the unit’s revenue from the first three months of the year – even after stripping out a benefit of almost $200 million from changes in the value of its own liabilities. The firm also enjoyed a $470 million gain on its exposure to monoline insurer MBIA after a stretch of losses.
The improvement helps Gorman on his way to hitting a FICC market-share target of 8 percent. That would nicely juice profits. But it won’t be as beneficial as cranking the firm’s wealth management unit up to full speed. Trading boasts a higher pre-tax margin – of, say, about 35 percent. But Gorman’s aim to boost Morgan Stanley Smith Barney’s profitability to 20 percent means doubling it from where it is now.
That might sound ambitious. But much of what’s dragging the business is the expense of integrating Smith Barney and upgrading the infrastructure, a cost shared with minority owner Citigroup. The job should be largely done by next year. If the pre-tax margin target can be met, brokerage revenue grows 10 percent and Morgan Stanley increases its stake to 64 percent, for 2012 it would mean $1.6 billion of net income for Gorman’s firm – or triple what it banked last year.
That’s a bigger boost to the bottom line than the $650 million or so FICC would bring in by hitting its market-share goal, assuming industry revenue grows 10 percent. Brokerage earnings are also higher quality, as they require far less capital and risk. Ultimately, that’s the turnaround that matters most for Morgan Stanley.


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