The problem is that trading desks have high fixed costs that can’t necessarily be quickly brought down when revenues dry up. That can have an outsized effect on the bottom line.
This dynamic was on display in Morgan Stanley’s third-quarter results. Revenue declined 13% while profits fell 42% versus a year earlier. This was despite a 6% decline in non-interest expenses that included a 18% cut to compensation expense.
The negative operating leverage was even more evident in the bank’s institutional securities unit, which houses its investment-banking advisers as well as its traders. Revenue adjusted for accounting items declined 19.3% compared with a year ago, while pretax profit fell 77%.
Morgan Stanley can’t be accused of not using the tools at its disposal to combat the decline in profits. The bank slashed compensation in the institutional securities unit by 27.8%. It raised the amount of risk its trading desks take by nearly 30%. Neither was enough.
Although far less significant to overall results, the firm’s investment management business also had a bad quarter. And while the brokerage business helped to stabilize things, which is the point of having it, it simply wasn’t enough. The firm’s overall return on equity, after adjusting for accounting items, was slightly below 4%.
This highlights that Morgan Stanley remains highly dependent on how market winds are blowing. And, because of its small size relative to peers, it is the most likely to get blow off course when they are particularly harsh.
Write to John Carney at [email protected]