ClusterFICC: what Morgan Stanley's cutbacks mean for fixed income trading
The US firm's embarrassing re-rightsizing is not a knee-jerk reaction: it shows just how bad FICC revenues are likely to be in the longer term. Will other banks follow suit?
The headquarters of Morgan Stanley in New York
Morgan Stanley’s decision to cut almost 500 front-line staff from its fixed income, currencies and commodities business at the end of the year will be an embarrassment to the firm’s senior management.
They spent a large part of 2015 telling the market that its once-bloated FICC division had been right-sized after almost halving its risk-weighted assets, and that it had gone from a business that contributed around a third of group revenues to one generating little more than 10%. But it turns out, it wasn’t quite the right size after all.
The decision followed a very poor third quarter for Morgan Stanley. Earnings were hit by a slump in FICC revenues to $583 million, from $1.3 billion in Q2 2015 and a heady $1.9 billion in the first quarter of the year.
After that strong first-half performance, Morgan Stanley was trumpeting its success. Chair and CEO James Gorman told Euromoney in July that the first quarter was “proof of concept for us in FICC and as a firm.”
At first glance, the decision to further cut FICC looks like an over-reaction to one bad quarter. Analysts certainly laid into Gorman during the Q3 conference call; at the time, Gorman stood his ground, saying judgment of his strategy should not be based on a single quarter.
But Morgan Stanley’s leaders have been concerned for some time about long-term trends in the FICC market. President of institutional securities Colm Kelleher told Euromoney during the summer: “We’re not a Morgan Stanley FICC story any more, as we were for a number of years. Now we’re part of the overall FICC challenge story.”
That challenge is not dissipating. The global revenue pool has fallen dramatically since the financial crisis, and continues to slide. The firm’s decision looks like an attempt to get ahead of the inevitable. What was once a near-$200 billion-a-year global business could easily fall well below $100 billion in 2016.
Morgan Stanley’s expectation – certainly before the latest cuts – is that its FICC business should be able to win around 6% of the global revenue pool. That suggests the $600 million it earned in the latest quarter is in line with expectations. It also earned $600 million in the fourth quarter of 2014. The blip increasingly looks like it was on the upside in the first half of this year.
Not so comfortable
Where does this leave Morgan Stanley? To go back to Gorman, here's what he said in July: “Look at our Q4 2014 and Q1 2015 numbers. We can generate good returns for the firm off FICC revenues of $600 million, as we did in Q4. In a good quarter like Q1, we can earn considerably more than that – revenues of $1.9 billion, to be exact. So we have a business which is roughly 20% of the whole firm, where, with the right market conditions, there is significant upside potential. I am quite comfortable with that position."
Six months later, he’s not so comfortable after all. A reduced overall market, and a contraction in market share that will surely follow the latest round of redundancies, could make $600 million look like a good quarter for Morgan Stanley; even that baseline number looks certain to fall.
Gorman must hope that his wealth, advisory and equity trading businesses – all of which remain strong – can fire on more cylinders to get the firm into sustainable double-digit return-on-equity territory.
What does it mean for other big investment banks, most of which had a tough third quarter? So far, its Wall Street counterparts are holding firm. But they’ll be looking ahead anxiously, not wanting to be seen as slow to react to changing market conditions, nor Morgan Stanley’s decision. They’ll also have noted the very positive response of most analysts and investors to Kelleher’s announcement.
Analysts at Morgan Stanley expect the decline in Wall Street’s FICC revenues, which has been proceeding at a compound annual rate of around 9% since 2009, to continue into 2016 and 2017. Even the biggest banks are concerned at the penalties through G-Sib (global systemically important banks) capital surcharges of maintaining large balance sheets devoted to poorly returning FICC business. They are much keener to grow in equities, underwriting and advisory.
And it’s not just a question of the overall market. As Euromoney’s December cover story revealed, a growing band of non-bank market makers is muscling in on FICC, unencumbered by the regulatory and capital burdens that the big banks face. They will expect to take market share.
FICC trading may become a specialist business for niche players with better and technology than the banks, more capable of updating risk exposures in fractions of seconds and redeploying precious capital at higher velocity.
One thing is for sure: the FICC challenge story, which Kelleher spoke of and of which Morgan Stanley remains a part, has some way to run.