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Opinion

Macaskill on markets: Cautious Goldman clashes with Morgan Stanley’s upbeat tone

Goldman Sachs cut out trading completely in the first quarter – at least that’s what the language of its earnings filing indicates. The bank managed to avoid using the t-word at any point in its earnings announcement, although it mentioned clients 29 times and made 46 references to investment.

Jon Macaskill is one of the leading capital markets and derivatives journalists, with over 20 years’ experience covering financial markets from London and New York. Most recently he worked at one of the biggest global investment banks

Jon Macaskill is one of the leading capital markets and derivatives journalists, with over 20 years’ experience covering financial markets from London and New York. Most recently he worked at one of the biggest global investment banks

Goldman put in a very respectable trading performance in the first quarter, with strong results across fixed-income and equities markets. It continues to take a much more cautious approach to capital deployment than its peers in advance of the implementation of pending regulatory changes, however.

This suggests that Goldman has either been spooked by the public relations battering it endured last year or that its less-disciplined competitors are underestimating the effects of coming changes to key sales and trading markets.

History suggests that the latter is more likely to be the case.

While Goldman Sachs CFO David Viniar was guarded to the point of gloominess in his conference call with analysts to discuss first-quarter results, Morgan Stanley CFO Ruth Porat was much more upbeat.

Porat and Morgan Stanley chief executive James Gorman were attempting to convince analysts that Morgan Stanley had finally turned the corner in reviving a sales and trading franchise that has been underperforming for four years.

Equity results backed their premise. Sales and trading revenues of $1.7 billion were the highest recorded for a quarter since 2008, driven by solid performance across cash and equity derivatives markets, especially in Europe and Asia. Morgan Stanley was still behind the $2.32 billion of equity client services revenue recorded by Goldman Sachs, the sector leader. And Goldman racked up another $1.05 billion in equity securities gains (which are not to be called trades, of course). But Morgan Stanley managed an increase in revenue compared with the same quarter in 2010, unlike Goldman. Morgan Stanley also seems to have a clear plan and sufficient scale to pursue growth and market share gains in equity trading, the business line that will suffer least from the transition to new risk weightings under the incoming Basle III capital rules.

The same cannot be said for Morgan Stanley’s troubled fixed-income franchise. Gorman and Porat both strained to talk up the progress made in fixed-income sales and trading, where revenues of $1.8 billion were at least an advance on the loss made in the last quarter of 2010, although down by 35% from the same quarter last year.

There were tangible signs of progress in rates trading, where revenues were up 10% year on year, helped by an increase in liquid flow product returns of more than 50%. And commodities revenues were up, as would be expected after a quarter of renewed volatility and price rises. But Morgan Stanley continues to suffer from serious fixed-income trading stumbles. It recorded a loss of $318 million on monoline credit spread tightening, driven by its unwinding of high-premium MBIA credit default swaps. Morgan Stanley sold so much default swap protection on MBIA in the first quarter that dealers elsewhere assumed it had at least managed to unwind its entire exposure to the monoline (see Macaskill on markets: Morgan Stanley derailed by monoline exposure, Euromoney, April 2011). Instead Porat said that Morgan Stanley "adjusted some of our hedges", noting that "correlations are breaking down, complicating credit hedging". This raises the prospect of further MBIA-related losses if its spreads contract further – which they did as soon as Porat had made her remarks.

Gorman was forced to follow his comments extolling the recovery in Morgan Stanley’s global fixed-income franchise with an explanation of the impact of a $665 million loss in fixed-income trading made in a joint venture with Mitsubishi UFJ Financial Group. The loss was incurred by MUFG, not by Morgan Stanley’s own Tokyo staff. And Gorman was able to use financial jujitsu to talk an embarrassed MUFG management into offering a good deal on conversion of its preferred stock holding in Morgan Stanley. But the two episodes certainly do not inspire confidence in Morgan Stanley’s ability to continue its pursuit of an ambitious goal of a 2% increase in global fixed-income market share without further mishaps.

Gorman’s frustration with the slow progress in turning around the bank’s fixed-income franchise was evident. "This is the first time I have felt confident with the leadership across all our fixed-income businesses," he said, praising current (and former) fixed-income head Kenneth deRegt as "mature".

We can probably infer from this that deRegt’s immediate predecessor, Jack DiMaio, will not be invited to any Gorman family barbecues this summer.

Porat echoed the importance placed by Morgan Stanley on getting the right staff in place, by citing additional talent as a reason for the progress made in rates trading. This was presumably a reference to the hiring of Glenn Hadden from Goldman Sachs as head of interest rate trading, although he has only been in place since January, when Morgan Stanley replaced DiMaio.

Although Morgan Stanley has overhauled its fixed-income management and increased its revenue in rates, it admitted that it still has work to do on the central problem facing the sales and trading units of investment banks: adjustment of risk-weighted assets ahead of the implementation of the Basle III capital rules. The bank said that it had cut its risk-weighted assets from $330 billion to $300 billion between December 31 2010 and the end of the first quarter, as measured by Basle I rules. But Porat said it was premature to commit to a mitigation number under the coming Basle III framework, and repeated guidance that a rise in RWAs to $480 billion was likely because of the transition to the new rules.

All the big fixed-income players face a tough job in adjusting their businesses to the change in risk weightings under Basle III but the transition will be especially tough for such firms as Morgan Stanley and UBS that are simultaneously trying to meet ambitious targets for increased market share.

UBS appeared to signal a compromise over risk-weighted asset reduction between its fixed-income staff and senior management at the bank, when it announced first-quarter results at the end of April. The bank said that it had decided to keep its risk-weighted assets flat to the levels seen at the end of the first quarter for the remainder of 2011. That was presented as a prudent reaction to coming regulatory change, although it could also be seen as compromise by senior management. Chief executive Ossie Grübel could have enforced RWA reduction this year but as a former trader he appears to have bought into the view that cutting dealing capacity would undermine the project to return UBS to the top tier of investment banks.

Like Goldman, UBS is working with a higher capital base than many of its rivals, although unlike Goldman this is a result of Swiss regulatory diktat rather than choice. That means that both firms – along with the wider industry – are now heavily reliant on exceptionally strong client flows if they are to have any chance of meeting decent return on equity targets.


see also:

Sideways: Can Q1 results staunch flow from UBS?

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