Best investment bank 2015: The reinvention of Morgan Stanley
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Best investment bank 2015: The reinvention of Morgan Stanley


Under the leadership of James Gorman, Morgan Stanley has carved out a unique position in global banking. It remains a great investment bank. Its much-maligned FICC division now looks fit for purpose. And its US wealth management arm gives the firm new stability and strength. Most important of all, the disparate parts of a once-divided business are delivering the benefits of the whole firm. And the markets are starting to realize the potential of a new Morgan Stanley as well.

At the end of every working day, James Gorman picks up a plastic folder and takes out the top sheet of paper. In an era when everything has become electronic, the sheet is something of a throwback. The half dozen lines that run from top to bottom are hand-drawn. The spidery numbers within it are written by Gorman’s own hand. 

These are the key end-of-day numbers for Morgan Stanley, the business that Gorman runs. Since he became chief executive in 2010, Gorman has religiously written down those numbers more than 1,200 times.  In those 1,200 working days, and countless weekends besides, Morgan Stanley has been transformed under Gorman’s leadership. When he took over as CEO, the bank had been through a near-death experience during the financial crisis just two years earlier. 

A big investment from Japan’s MUFG and the purchase of the Smith Barney retail business from Citi helped to steady the ship. But Morgan Stanley faced two big, related problems: the markets did not know what the firm was; and even many of the firm’s employees weren’t sure what it wanted to be either. 

Previous CEO John Mack had put the building blocks in place to rebalance the business. But the firm under Gorman did not deliver for some time. Margins in the new, enlarged wealth management business were in the low teens, poor for a division with $2 trillion in assets. While Morgan Stanley’s advisory and equities divisions continued to perform well, quarter after quarter results were hampered by a FICC business that hardly seemed fit for purpose. And the investment bank struggled to bring the whole firm to its clients, in part because of the uneasy relationship between the two bankers who ran it – M&A specialist Paul Taubman and markets veteran (and former CFO of the firm who played a key role in pulling Morgan Stanley out of the financial crisis) Colm Kelleher.

Then there was Gorman himself, the ex-McKinsey consultant and former head of wealth management at Merrill Lynch, brought in by Mack in 2006 to sort out the mess of its own wealth business – itself the legacy of the hated era following the firm’s merger with Dean Witter Discover, which many felt had ripped the heart and soul out of a once-great franchise. 

It hasn’t been an easy ride. Gorman admits that, even during the first two years of his leadership of the firm, many saw him as an outsider. “I was acutely aware of it,” he says. “It was entirely understandable. This is a very proud institution.” Some people clearly thought one of their own should be running the firm.

A crunch point came in February 2013. Gorman had bet his career on the new model and needed to convince investors. He could not start to do that until he was sure his own staff were onside.

He called a meeting of the firm’s top 250 senior managers across all business lines. The strategy was presented. The senior managers were given the chance to vote, anonymously, on whether or not they supported it. 

The result was clear-cut: 97% voted in support. “As soon as I saw the result, I knew we were on the way to getting where we needed to go,” says Gorman. 

For the past three years, those watching Morgan Stanley closely would have noticed a change, even if the group-wide return on equity numbers remained steadfastly disappointing in the mid-single digits. 


The wealth management division benefitted hugely from the merger with Smith Barney to become a clear leader in the US. Capital markets and financing divisions began to fire, and were no longer the poor relation of the advisory arm. Kelleher took a firm grip of the FICC division and remorselessly reduced it to a much more manageable size for the current regulatory environment – from $9 billion of revenues, or 32% of the business, in 2006 to a little over $4 billion in 2014, or just 12% of firm-wide revenues. 

And perhaps most remarkably of all, given the history of the firm, the investment bankers started not just to see but to tout the benefits of the wealth management arm to both the overall firm and to their own side of the business. 

Much of that flows down from the top management team. The three senior leaders of the business – Gorman, Kelleher and president of wealth management Greg Fleming – clearly get on well. There’s a great deal of mutual respect. Each has had a long, varied and successful career. These are not banking automatons: all three are quite likely to take the conversation off on a tangent and talk about something completely different. But when they are on message, they are sharp as tacks and straight to the point – and often thought-provoking, too.

When both Fleming and Kelleher say words to the effect of: “You don’t get the warm and cuddly with James,” it’s done with a smile and great deal of warmth and respect.

The trio breakfast together regularly – just them, no advisers. Here, they formulate the key strategic decisions for the firm and make sure their businesses stay focused on working better together.

Gorman may have a reputation as a cold fish, but he’s enormously engaging to interview, leaping from his conference table to his desk to get the details to back up his claims, leaning forward to make a point, raising his arms in a mock celebration of victory when he bats back a criticism from Euromoney, even inviting your correspondent to a putting competition on the way out of his office (he lost).

He certainly inspires loyalty from those closest to him. Kelleher says: “James is a strategic thinker and a collaborative leader who builds cohesive teams. He selects people carefully and then empowers them without micromanaging. We decide together on strategy, but he leaves me to get on with the execution.”

Fleming, who is perhaps the only senior banker to have left Merrill Lynch, after being there through the financial crisis, with his reputation intact and arguably enhanced, tells a similar story: “When we have differences of opinion, we’ll talk it through. If we still don’t agree, he’ll often say: ‘OK, it’s your business, it’s your call.’ There’s a huge amount of respect in the relationship.”

Now, Morgan Stanley is starting to earn respect from the market. Its share price is up 26% over the past year, slightly outperforming Goldman Sachs and well ahead of JPMorgan’s 8% rise in that time. 

More than that, the first quarter of 2015 might be the turning point that shows the new Morgan Stanley is proving Gorman’s model works. 

James Gorman: "We made some tough decisions to get to this point"

Return on equity broke into double digits for the first time since 2007, at 10.2%. Net revenues were $9.9 billion, up from $9 billion in the first quarter of 2014. Wealth management hit Gorman’s pre-tax margin target of 22%. The dividend was increased by 50%. And just as important was the balance of the business: net revenues in Kelleher’s investment bank, known as the institutional securities group, were $5.3 billion. Within that division, advisory revenues were $471 million; equity sales and trading were $2.3 billion; and in FICC, they were $1.9 billion. Combined net revenues in Fleming’s wealth and investment management business were $4.5 billion. 

Gorman is not declaring victory yet. He knows one good quarter is far from enough. He also knows that numbers for the fourth quarter of 2014 were a huge disappointment after a good start to that year, depressing full-year ROE to 7.5%, largely because of a very poor quarter in FICC.

But he is claiming at least vindication of his strategy. “We made some tough decisions to get to this point,” says Gorman. “And it’s great for everyone who stuck with us – whether it’s our employees, our shareholders, or our clients – to be in this position.”

When Moody's downgraded Morgan Stanley to triple-B in 2012, it’s argument went something like this: one, Morgan Stanley’s earnings were not covering its cost of capital; two, management would come under increasing pressure to do so; three, Gorman and his colleagues would be forced to increase risk to get those earnings up; four, whenever Morgan Stanley tried to increase its risk profile in the past, it screwed up; five, further down the line, that risk-induced screw-up would hit earnings.

Morgan Stanley insiders admit all those arguments were fine, except the most crucial one in Moody’s hypothesis: the firm did not increase risk. As Morgan Stanley’s rebalancing took root, Gorman quietly fumed that Moody’s would not budge on the triple-B rating. The problem, of course, was that earnings were still not covering the cost of capital.

In the first quarter of 2015 came the numbers that allowed Morgan Stanley to thumb its nose at Moody’s. Underlying return on equity at normalised tax rates came in at 11%. This was achieved with falling value at risk and a decline in risk-weighted assets. “The numbers speak for themselves,” says Gorman.


Those numbers also spoke to Moody’s (and Gorman won’t be drawn on whether he made a call to the rating agency to point out the first quarter numbers, or that fault in their 2012 hypothesis). In May, Morgan Stanley was upgraded two notches, from Baa2 to A3. 

It was an important moment for a number of reasons – and in particular the under-pressure FICC business.

Before 2012, Morgan Stanley’s share of global FICC revenues was generally around 7.5% of the market. After the Moody’s downgrade lost the firm its single-A-rated status, it lost a lot of business – about 2.2% of market share. In a $100 billion-a-year revenue industry, that’s a loss of more than $2 billion of revenues. The business leaves quickly after a downgrade and takes a lot longer to come back – if it ever will, given the cuts Morgan Stanley has made to the division. But for the first time in a long time, there is tailwind in the firm’s most challenged area. 

Gorman says the first quarter double-digit return on equity is sustainable in the medium-to-long term, although with macro uncertainties he can’t say it can be repeated quarter-on-quarter this year. But he points out that Morgan Stanley’s ROE has been on a sustainable rise, up around two percentage points a year for the past three years. He expects that to continue in the years to come. That puts a steady, if far from spectacular, ROE of 12% within touching distance. 

How? Gorman points to three factors. First, there’s the global macro recovery. By far the biggest of Morgan Stanley’s exposures, with its huge retail brokerage arm, is to the improving US economy. It is also a play on a recovering Japan, where the firm’s securities and brokerage joint ventures with shareholder MUFG are confounding sceptics and challenging incumbents such as Nomura domestically, while other international banks decide whether or not to try to build up again.

Second, there’s the competitive environment. While European banks such as Barclays, Credit Suisse and Deutsche Bank consider how to shrink their balance sheets, and probably contract their markets businesses, Morgan Stanley has been through that process already. In the third quarter of 2011, the firm had around $390 billion of risk-weighted assets in its fixed income division. Today, that number is closer to $175 billion.

Yes, its FICC revenues have suffered in the meantime. But they’re picking up again: in the first quarter, helped by a return of volatility that boosted all firms, FICC revenues jumped to $1.9 billion compared with just $600 million in the fourth quarter of 2014. 

“The first quarter was a proof of concept for us in FICC and as a firm – showing that in favourable market conditions, without increasing the balance sheet, fixed income can be a meaningful contributor that leads to a firm-wide return on equity of better than 10%,” says Gorman.

Indeed, after the Moody’s upgrade, a number of clients were quickly on the phone to Gorman – among them some of the world’s biggest fund managers – inviting Morgan Stanley to reopen lines with them. One even sent pizza to the entire FICC trading floor as a ‘lets do business together again’ gesture. 

And it hasn’t escaped the notice of Morgan Stanley bankers that one of the firms they hope to win FICC business from – Deutsche Bank, now by far the biggest of the European houses – suffered a downgrade to triple-B status from Standard & Poor’s in June, the very downgrade that cost Morgan Stanley market share three years ago. 

A corner has been turned: “We’re not a Morgan Stanley FICC story anymore, as we were for a number of years; now we’re part of the overall FICC challenge story,” says Kelleher.

It’s also a business that is starting to attract talent again. Kelleher points to the recent hire of Kay Haigh as global head of emerging markets as an example. Haigh was a former head of emerging markets trading at Deutsche Bank. 

“Throughout the crisis we were able to hire top people in M&A and equities, now we’re increasingly able to do it in FICC and capital markets,” says Kelleher.


But don’t mistake this enthusiasm for FICC with a desire to chase the firm back to the top of the FICC rankings. “In all our other business lines, we aspire to be at least a top-three player. We have no aspiration to be back in the top three in FICC. That is not our model,” Gorman says firmly. “We want to make the best return we can on the capital and resources we are comfortable to commit.”

Third, there’s what Gorman describes as the “idiosyncratic” nature of the new-look Morgan Stanley. Some say, with the combination of investment banking and wealth management, he has tried to recreate the old Merrill Lynch, where he worked until 2006.

Gorman doesn’t see it that way. The day before Euromoney visits him in mid-June, Morgan Stanley has just taken receipt of the final deposits it acquired with the purchase of the Smith Barney brokerage from Citi. 

“We have a $130 billion deposit base, which would make us the 10th largest bank in the US,” says Gorman. “The opportunity to grow that bank through prudent lending to our clients is incredible.” 

That deposit base already puts Morgan Stanley on a par with a US consumer bank such as BB&T, which has a market capitalization of around $30 billion. Is that sort of value realized in Morgan Stanley’s stock price? And, with the Fed likely to start raising interest rates soon, the firm is set to benefit from a natural up-tick in revenues. 

Colm Kelleher: “We’re not a Morgan Stanley FICC story anymore, as we were for a number of years; now we’re part of the overall FICC challenge story"

People who know Gorman well say that, as an ex-McKinsey consultant and at-heart wealth manager, he struggles to get comfortable with the profit and loss volatility that a business exposed to market fluctuations must endure. 

Gorman sees it all from a holistic point of view. “The investment bank is fantastic and remarkably resilient. So is our equities business, which is the best in the world. In asset management, we’re not worried about size, but we do care about revenues and returns, and we’re doing well there. And the wealth management business is the railroad on which we can drive the whole firm forward.”

As for that volatile markets business, Gorman says: “Look at our fourth quarter and first quarter numbers. We can generate good returns for the firm off FICC revenues of $600 million, as we did in the fourth quarter. In a good quarter like the first, 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.”

And what of the client business within the investment bank, which remains the most high-profile indicator of the health of the firm? Morgan Stanley continues to occupy its seemingly immovable top-three position in equity capital markets and M&A, although it has one big gap in particular to close on arch-rival Goldman Sachs. 

As you’d expect, it advised on five of the biggest completed global M&A deals of the last year. It is now actively advising on the two biggest deals currently in the market: the $81 billion Royal Dutch Shell-BG takeover and the $78 billion Charter-Time Warner deal. 

Its equity capital markets team has been on a large proportion of key deals, such as the Citizens IPO and of course the landmark Alibaba listing. 

But Morgan Stanley is also showing up in places you might not expect.


Gorman says the advisory businesses are much more joined up with capital markets these days, and credits Kelleher – who became sole president of ISG after Taubman left in 2012 to set up his own advisory firm – for making them such. “The fact that Colm has a trading and capital markets background has really helped to bring the two areas together. We’re now much better at bringing the whole firm to our clients. This is a leaner, more focused place.” A great example of this is its work for pharmaceuticals group Abbvie. Completed in May this year, Abbvie bought leading oncology firm Pharmacyclics for $19.9 billion. Morgan Stanley was not just the key adviser to Abbvie. In March, to ensure that Abbvie was in the best position possible amid a highly competitive M&A process for Pharmacyclics, it arranged a full $18 billion 364-day bridge commitment within a matter of days. 

It’s the biggest committed financing of the year so far – not something you would always have associated Morgan Stanley with.

Not only that, it was a clear incidence of the joint venture with MUFG working: Morgan Stanley provided $14 billion of the commitment, while its Japanese partner stumped up the remaining $4 billion.

After winning the M&A bid, Morgan Stanley quickly followed up on May 5 as lead left bookrunner on a $16.7 billion bond deal for Abbvie. The deal generated $60 billion in orders.

Just one day after that, Morgan Stanley was one of the bookrunners on a $10 billion bond offering across five tranches for Shell in the US market, the second biggest yankee bond of all time. 

Morgan Stanley is getting better across debt markets. Another growing business is its leveraged finance franchise. It’s run by Dan Toscano, a veteran leveraged financier who had previously worked for Bankers Trust and Deutsche Bank.

Toscano had come close to joining Morgan Stanley before. But both times, in the late 1990s and mid-2000s, he backed away from the opportunity, feeling that senior management did not really understand the acquisition finance business and were getting into it not so much because they wanted to, but because they felt they had to. 

So when Morgan Stanley came calling again in 2010, when Toscano was taking a break from the markets, he went to 1580 Broadway for a third time. But not before telling his wife to expect him home pretty soon – he didn’t foresee the opportunity being any more appealing on this occasion, and anticipated a swift and unsuccessful meeting. 

He’s now been at the firm for five years. “It was clear that Morgan Stanley had finally connected the dots. Event finance completed the circle around its great advisory and equity capital markets businesses. Now we have a globally integrated finance platform.”

Over the last 12 months, the bank has done more leveraged finance business than ever before. This included a $5.1 billion bond offering for Dynegy last October, the biggest US high-yield financing in 2014; and a 100% Morgan Stanley-underwritten $3.5 billion financing for long-term client Zebra Technologies for its acquisition of Motorola Solutions’ Enterprise.

greg fleming
Greg Fleming: "Our financial advisers and their clients are now getting full access to products and ideas that used to just rest in the institutional side of the business. That benefits the whole firm"

It's not just the disparate arms of the institutional securities group that are better aligned. Fleming says he and Kelleher are working to bring the wealth and investment banking parts of the business closer together. This includes getting top investment bankers to forge closer relationships with the best brokers. That didn’t happen in the Dean Witter days. 

For example? “We’ve got great tech investment bankers. We also manage a lot of money for tech entrepreneurs, managed by some of our top-rated financial advisers. These guys are getting to know each other, they respect each other, and they are seeing the benefits of working together,” says Fleming. 

The coming-together also involves some important people moves between the businesses. In March, Morgan Stanley veteran Raj Dhanda, who had run the equities and capital markets businesses in the institutional securities group for a number of years, moved across to the wealth side. There, he’s in charge of all products and services for wealth. 

The executive Dhanda replaced as head of investment products, Andy Saperstein (a former colleague of Gorman’s at Merrill Lynch), has moved across to become chief operating officer of ISG. Elizabeth Dennis, a 14-year veteran of the capital markets group and former debt syndicate staffer, has since June been in charge of selling all bonds and equities through the retail network. 

“Our financial advisers and their clients are now getting full access to products and ideas that used to just rest in the institutional side of the business,” says Fleming. “That benefits the whole firm.”

To put that benefit into context: Gorman estimates that around 5% of the firm’s wealth clients, on average, are looking to do a deal on any given day. On a $2 trillion asset base, that’s about $100 billion a day of product that the securities group can service. Morgan Stanley ECM bankers get particularly excited at that prospect. 

And the Japanese joint venture is doing better than anyone expected. From Tokyo to New York, and all financial centres inbetween, Morgan Stanley bankers are delighted with their relationship with Japan’s MUFG, which took a 21% stake in the business in 2008.

More important today, perhaps, is the way the two banks are working together. First there’s the securities joint venture in Japan. Gorman is incredibly bullish about its prospects. 

“It’s helped make us clearly the number one foreign firm in Japan,” he says. Whisper it quietly, but Morgan Stanley has bigger targets in its sights, and wants its securities JV in Japan to be the clear challenger to long-term incumbent Nomura.

To be frank, it took a while for some people internally to grasp what we were doing. You have to start delivering consistent results and show the benefit of the strategy before investors will give you credit for it.
James Gorman

There’s also a 40% stake in a joint venture with MUFG targeting wealthy retail customers; Gorman says the distribution power within that business has huge potential for the whole firm. 

Then there are lending agreements in Japan, Asia and the US, where MUFG’s balance sheet can work alongside Morgan Stanley to provide financing to clients, such as the Abbvie bridge financing. 

All this leads to the question: could Morgan Stanley and MUFG do more together? Any kind of full-scale merger is certainly not on the agenda. MUFG’s leaders must be delighted with their investment: the stake which they bought for $9 billion in 2008 is now worth $16.8 billion, notwithstanding the revenues the ventures are making. 

But Morgan Stanley insiders say they have to tread a careful line – too much cross-participation might not pass Fed scrutiny and could lead to concerns about potential control issues. 

Back to where we started: Gorman’s hand-written rituals. There’s another: this one annual, rather than daily. At the start of each year, he writes down 10 key targets for the 12 months ahead.

One target is there on each of the six sheets he has produced as CEO. It reads, simply: ‘No new mistakes’. Gorman defines a mistake as something that would cost the firm 0.5% of its capital – in 2015 terms, around $350 million. So far, on every New Year’s Eve, he’s ticked that one off. 

On average, he’s managed to meet around seven or eight of the targets he has set the firm, and himself, annually. That’s no mean feat given the market, industry and regulatory uncertainties that have faced Morgan Stanley over the past five years. 

And don’t be fooled into thinking Gorman gives himself an easy ride. The targets are not for public consumption: these are the milestones a competitive, driven Australian sets for himself. 

Many of the targets are easy to define. Successes in 2014 included instituting the dividend and buyback policy (50% up and $3.1 billion over five quarters, after passing the Comprehensive Capital Analysis and Review test), and selling the firm’s physical oil unit. A near miss was the 22% margin target in the wealth business, but this was achieved in the first quarter of 2015. 

Others are less tangible. In 2012, for example, Gorman wanted to “re-energise the senior leadership team”; in 2013, he wanted the firm to “behave like winners”; last year, his aim was to ensure a “meaningful shift in culture” at the firm. 

One thing Gorman doesn’t put on his top 10 list are firm-wide RoE targets. Like all big financial institutions, Morgan Stanley has a lot more equity now than it did before: in 2010, it was about $40 billion; today, it’s $68 billion. 

The firm’s buyback policy and dividend ratio is now much closer to the capital it is accreting. And Gorman says the cost of equity is going down. 

The key is to consistently grow the returns. And that should get the share price – which was $12 in 2012, and is around $40 now – moving higher as well. The price to tangible book value is around 1.3 times – slightly ahead of Goldman’s at 1.25 times. But the target is another bank that, like Morgan Stanley, has rebalanced its business towards wealth management: UBS, which trades at around 1.6 times book.

And Gorman has put his money where his mouth is: since he became CEO, he has not sold a single penny of his near $50 million of Morgan Stanley stock; indeed, he’s one of very few US bank chiefs who have invested in his firm’s stock from his own account. To get more people buying the stock, investors need to understand the nature of the new Morgan Stanley. Gorman admits to some frustration in the past on this front. “With hindsight, I was wrong to expect investors to understand it earlier. To be frank, it took a while for some people internally to grasp what we were doing. You have to start delivering consistent results and show the benefit of the strategy before investors will give you credit for it.”

Now, Gorman’s message is clear, and easy to understand: “We have the ballast of wealth management and retail, and the engine of the investment bank. Our bet is that the market will like that combination. Our book is rock solid. There’s no reason why, if we continue to deliver, investors should not apply a premium to it.”

"I knew if we had 15,000 brokers with $2 trillion in assets, then we would always have the foundation of a stable business"

The deal that made Morgan Stanley's James Gorman


Clive Horwood
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