Morgan Stanley Won't Retreat After Beefing Up Trading Desk

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Morgan Stanley plans to maintain trading at the center of its business model despite weak trading results in the fourth quarter of 2009, says Colm Kelleher, co-president of the institutional securities division and former CFO.

The bank also says it set compensation levels that will make its global work force "significantly" share the burden of a pending UK tax on bonuses paid by banks.

The bank reported lower-than-expected fourth-quarter profits that included a 73 percent plunge in trading revenue compared with the third quarter. But Kelleher said on a conference call that trading remains "the engine room" for Morgan Stanley and he believes it will flourish this year. He says strategy for 2010 will focus on "execution...with a successful integration of Morgan Stanley Smith Barney, and resolving ourselves in trading."

Morgan Stanley's commitment of resources to trading and returns from it have lurched to and fro in recent years. After layoffs in 2008 left it sidelined during the early phase of last year's market rebound, the bank restaffed by adding some 350 new sales and trading professionals. Kelleher and CEO James Gorman took pains to reassure investors their current business model won't sacrifice risk controls in the pursuit of trading profits. However, Kelleher's remark that "we don't want to do a full proprietary trading" should taken with a grain of salt. Bulge brackets make money from prop trading, not flow trading, for the most part. And in finance it's always a case of no pain, no gain.

Last quarter, a broad industry-wide slowdown in fixed-income trading volume and profit drew attention from several analysts who lowered estimates for Morgan Stanley and other institutions - though evidently not low enough. Softer results from trading, especially fixed-income, also contributed to profit shortfalls reported by JPMorgan Chase and Citigroup earlier this week.

Traders Jobs Appear Safe For Now

But those fourth-quarter results don't yet signal a threat to traders' jobs, because many observers believe last quarter was just a calendar-induced blip in trading business.

Morgan Stanley quarterly fixed-income trading revenue totaled $1.2 billion, after excluding an accounting adjustment for credit spreads on the bank's own debt. The comparable third-quarter figure was $2.7 billion. Equity trading revenue excluding the credit spread adjustment came to $900 million for the fourth quarter and $1.3 billion for the third quarter.

Debt-related credit spread adjustments, which are booked as subtractions from revenue, also inflated the ratio of employee compensation to revenue within the institutional securities division and for the company as a whole. Media coverage spotlighted the 62 percent firm-wide percent compensation ratio for last year - highest since at least 1997 according to Bloomberg News - and a 57 percent compensation ratio for the institutional securities division, comprised of sales and trading, advisory and underwriting. However, Kelleher said the ratios excluding credit spread adjustments were 50 percent for the firm and 40 percent for institutional securities. (By comparison, JPMorgan this week reported a 2009 compensation ratio of 33 percent for its investment bank division.)

UK Bonus Tax Influenced Compensation Amounts

Kelleher said Morgan Stanley "considered" the impact of the UK's planned 50 percent tax on discretionary bank bonuses when it set compensation levels. If implemented, "the cost of this tax will be shared significantly by employees globally," he said, according to Bloomberg. Still, "Morgan Stanley will have to pay prudently to preserve its work force."

The bank's $14.4 billion compensation and benefits expense for 2009, up 28 percent from 2008, nevertheless came in below two analysts' estimates Bloomberg cited. Compensation was pushed up by the addition of 15,000 employees via a wealth management joint venture with Citigroup and by the addition of more than 350 sales and trading professionals, undoing part of the headcount reductions the bank had made during 2008.

Edited Jan. 21, 2010.

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