This is just the start of the layoffs at Morgan Stanley

Morgan Stanley is making another round of redundancies. According to various sources, it will be letting 1,600 people go from its investment bank. 800 will go in the US, 800 will go elsewhere and the cuts will reportedly be disproportionately oriented towards the most senior staff. 

It's clearly bad news if you have the misfortune to be a senior banker at Morgan Stanley. James Gorman warned in October that all investment bankers were overpaid, making it unlikely that bonuses at Morgan Stanley will be particularly gigantic this year. Last year, DealBook says 110 of 500 MDs in sales and trading received no bonus. This year, the proportion of zeroes will increase. And to compound the compensation woes, it now seems likely that many of Morgan Stanley's bankers will lose their jobs.

Bad as things are, however, they could get a lot worse. Morgan Stanley doesn't break out headcount in its institutional securities unit, but 1,600 job cuts amount to a mere 6% of the total. This seems modest - particularly given that Morgan Stanley spends an unusually high proportion of its revenues on staff costs  and that its fourth quarter return on equity is expected to be a mere 3%. 

This being the case, the 1,600 layoffs are likely to be the start of an iterative process which will continue over 2013. Most at risk are Morgan Stanley's fixed income professionals.

Morgan Stanley's shaky FICC foundations 

Analysts at Deutsche Bank are predicting that 2013 will be a bad year for fixed income revenues. Dodd Frank, European Market Infrastructure Regulation, preparation for MiFID 2 and the end of the spread tightening and high credit issuance of 2012 will all conspire to suppress sales and trading businesses, they say. Rates revenues could fall as much as 45-50% as a result. Overall, Deutsche analysts expect fixed income currency and commodities (FICC) revenues to decline 6% this year.

If you're a fixed income banker at Morgan Stanley, this should ring sonorous alarm bells. Last year was a good year for fixed income sales and trading: places like Bank of America increased their revenues 35% year-on-year in the first nine months of 2012. And yet Morgan Stanley's fixed income business, in which the bank invested heavily in 2009 and 2010, only managed to muster growth of 1% - a performance whose paucity was exceeded only by JPMorgan. It won't help that Glenn Hadden, head of global rates at Morgan Stanley, is under investigation for manipulating treasury futures and that Hadden's area - a major source of revenues in the past is shrinking anyway.

If Morgan Stanley can't achieve fixed income revenue growth in a strong market, what chance does it have in a weak market? And if Morgan Stanley can't grow revenues, it will very soon have to make some serious decisions about strategy.

As we've noted before, 2013 is a make or break year for Morgan Stanley's fixed income business. The bank's strategy looks fanciful at best and deluded at worst. Analysts at Sanford Bernstein point out that it intends to cut risk weighted assets in its fixed income business by 30% before 2015 whilst simultaneously increasing its fixed income market share by 30% (from 6% to 8%). This would be a near-miraculous feat.

"Morgan Stanley's fixed income business cannot beat its cost of capital under new regulatory constraints," Brad Hintz, equity research analyst at Sanford Bernstein tells us. "And the only way to improve performance is to reduce balance sheet and to cut staff."

Could Morgan Stanley pull out of fixed income in the style of UBS? Last year, Colm Kelleher, head of the investment bank reportedly told a private dinner of Morgan Stanley shareholders that he had no intention of imitating the Swiss bank. However, a fixed income exit can't be ruled out. Dealbook says Morgan Stanley's board has discussed pulling out altogether. And yet the bank's fixed income business does have its cheerleaders. Analysts at Deutsche Bank, who this week slated UBS's fixed income strategy as unworkable seem to think that Morgan Stanley will be one of the main beneficiaries of UBS's decision to pull back in fixed income. As the chart below shows, Deutsche Bank analysts are predicting a 30% increase in FICC revenues at Morgan Stanley this year. Morgan Stanley's FICC bankers need to hope fervently that they're right.