However you look at it, something exceptional has happened in Morgan Stanley's fixed income trading business. In the fourth quarter of 2016, revenues were up 220% on the previous year. Ok, there was Trump. Ok, there was the turn in the interest rate cycle, but J.P. Morgan and Bank of America benefited from those events too and they only managed Q4 increases of 21% and 12% respectively.
It might be argued that Morgan Stanley had the advantage of coming from a lower base. This would, indeed, be true: in the fourth quarter of 2015, fixed income trading revenues at Morgan Stanley were only $460m, compared to $2.8bn at J.P. Morgan and $1.8bn at Bank of America. It will always be easier to achieve a 220% year-on-year increase from an almost standing start.
Morgan Stanley's fixed income achievement shouldn't be entirely discounted on the basis of size though. As the chart below shows, the U.S. bank has achieved something impressive in the past three years. And as management like to remind everyone, it's done so with 25% fewer fixed income sales and trading staff and 44% fewer risk weighted assets in the fixed income business (RWAs are in billions in the chart below) .
How can this be? James Gorman didn't shed much light on the issue today, but his earlier comments offer some explanation.
It's all down to velocity
Morgan Stanley's fixed income trading miracle - namely, its huge increase in revenues simultaneous with a significant decrease in risk-taking and risk weighted assets (RWAs) is almost certainly the result of James Gorman's policy of ramping up the bank's "balance sheet velocity." This is the rate at which it uses its risk weighted assets (RWAs) to generate revenues.
Gorman last mentioned the bank's policy of improving the velocity of risk weighted assets in its fixed income business in his investor presentation a year ago. Helpfully, Morgan Stanley's own banking analysts also provided a lengthy exposition on the importance of the policy in their banking outlook report from 2011. By increasing the "fungibility" of RWAs (ie. the ability to move them between trading businesses) and by monitoring the metrics around RWA velocity and thereby ensuring assets don't get tied up in low revenue and illiquid positions, they said banks would be able to offset the pressures of shrinking trading margins and increasing costs.
Morgan Stanley appears to have taken this advice to heart. All banks have been busy optimizing their balance sheets; none has done so to such good effect as Morgan Stanley.
The people responsible for this transformation aren't Morgan Stanley's fixed income traders and salespeople. While they deserve some of the credit for the bank's increased revenues, it's the bank's liquidity and balance sheet specialists behind the scenes that have driven the increased velocity of its RWAs. Several have arrived in the past few years. - Morgan Stanley's global head of capital and balance sheet management, Frank Tredici, joined from Credit Suisse in 2010. Its COO of global capital and balance sheet management, Jennifer Haupt, joined from Citi in 2012. Jim Brooke, its EMEA head of business unit capital and balance sheet management, was an auditor at Marks & Spencers who joined Morgan Stanley as a controller in 2007 and was promoted to head of EMEA RWA allocation last year.
Morgan Stanley is said to be rewarding its fixed income traders with higher bonuses for their efforts in the fourth quarter; it might want to reward these balance sheet-crunchers too.
Year-on-year, it's Morgan Stanley's M&A bankers who stand out though
Separately, even though Morgan Stanley's fixed income business had an exceptional fourth quarter, the same can't be said of its performance across the year.
As the chart below shows, J.P. Morgan remains the stand-out performer in fixed income sales and trading for 2016 as a whole. Morgan Stanley's strength lies in M&A, but other areas of its investment banking division are struggling: it significantly under-performed in equity capital markets (ECM) and debt capital markets (DCM)..
Gorman is optimistic nonetheless. In the slide below, from the presentation accompanying today's call, Morgan Stanley promises to hire in equities trading, particularly in Asia, and to 'deepen its bench' in fixed income.
Although Morgan Stanley is going to stop disclosing risk weighted assets assigned to its fixed income business in future, further increases to 'trading velocity' are also on the cards. Morgan Stanley's balance sheet optimization specialists haven't finished yet.
Strategic priorities for Morgan Stanley's sales and trading business in 2017:
Source: Morgan Stanley
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