Things you might want to think about before joining Morgan Stanley’s fixed income business

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Shall I join Morgan Stanley's FICC business?

We’re not saying that Morgan Stanley is hiring. According to its website it has a mere two jobs going in its front office fixed income business in London – both for rates traders. But if you are feeling friendly towards Morgan Stanley following last week’s blowout fixed income results, there are a few reasons why you may wish to dampen your ardour. We leave it to you to decide whether they’re valid or not.

1. Morgan Stanley definitely did well, but maybe Goldman didn’t do so badly after all

Glenn Schorr, US banks analyst at Nomura, has been scrutinising the figures.  He points out that whilst Morgan Stanley’s fixed income business clearly performed far better than any of its peers in the first quarter, Goldman didn’t do quite as badly as initially seemed.

Specifically, says Schorr:

“If you look at 1Q12 data versus the average from 1Q10-4Q11 (basically excluding 2009), Goldman goes to +29% vs. -9%. Secondly, if you look at Goldman’s FICC revenue and add in the Debt revenue from its Investing & Lending segment (which is similar to how Goldman used to report its FICC trading), the picture changes. Under that scenario (Figure 4), it looks like JPMorgan and Goldman had similar quarters compared to their average performance while MS, BAC, and Citi all showed a lot of progress. We think this tells the story of rebounding franchises that lost ground during the financial crisis while the top performers, JPMorgan and Goldman, have maintained their strength. “

Schorr’s charts are below.

2. Morgan Stanley’s success may not endure

More pertinent, however, is the question of whether Morgan Stanley can sustain its fixed income outperformance beyond the first quarter. Here, analysts are sceptical.

The really big issue is Moody’s threatened downgrade of Morgan Stanley’s debt to BAA2 in May 2012. Anyone joining Morgan Stanley’s derivatives trading business especially has reason to be concerned as a result.

“Moody's prospective downgrade will result in ≈$5 billion in incremental collateral posting to derivatives counterparties by MS, as well as modest increases in funding costs by the firm,” says Schorr. “This is manageable. The most severe impact of Moody's potential action will be a decline in the market's appetite for Morgan Stanley's longer dated derivatives and limitations on trading lines – this will play out over time and serve as another headwind to MS' plans for improving sustainable fixed income performance.”

Last week, Blackrock chairman Lawrence Fink said the company may be obliged to withdraw business from ‘some banks’ if they’re downgraded so that it can meet its clients’ portfolio requirements.  Some clients promise investors that their funds will only traded through investment-grade banks.

Schorr says this may not be a massive issue for Morgan Stanley, which has already taken defensive action. Firstly, structured derivatives will be most affected by the change and Morgan Stanley has already shifted towards more cash-driven products. Secondly, within structured derivatives only 8% of Morgan Stanley’s contracts will apparently be impacted by Moody’s move. Thirdly, Morgan Stanley has moved a lot of its business to central clearers, which are less impacted by ratings changes. And fourthly, Morgan Stanley has a higher rated derivatives entity and has apparently been moving its derivatives business over there.