Morgan Stanley Could Benefit From Some Fed Decisions

Morgan Stanley

Morgan Stanley is positioned for a liftoff, but the timing is in the hands of the Federal Reserve.

Solid trading and cost cuts left the Wall Street bank earning $1.5 billion in the third quarter, 62 percent higher than in the same period last year. That put annualized return on equity just shy of 9 percent, the lower end of the target that James P. Gorman, Morgan Stanley’s chief executive, had set for 2017. Some help from America’s central bank could push the return closer to 11 percent, a figure that would rival Goldman Sachs’s.

The Fed could, for one thing, raise interest rates. That would add extra juice to Morgan Stanley’s relatively new lending unit within its global wealth management division. It has $150 billion of customer deposits but has so far lent out less than half that amount — though it grew at a fast clip of 26 percent compared with last year’s third quarter.

A bigger lift would come if the Fed allowed Mr. Gorman’s company to buy back more stock. Morgan Stanley is one of the best capitalized banks, with a common equity Tier 1 ratio of equity to risk-weighted assets of 15.9 percent by the most up-to-date standards. That compares to 13.4 percent at Goldman. Were Morgan Stanley able to pay out capital and reduce its ratio to that level, its annualized return on equity last quarter would have been as high as 10.6 percent.

That will not happen just yet, though. The largest banks are still waiting to find out the implications of newly defined capital buffers outlined last month by Daniel K. Tarullo, a Fed governor. The changes are not scheduled to take effect until next year, meaning lenders will not be able to factor them into capital-return plans until the Fed runs its 2018 stress tests.

In the meantime, shareholders can feel some confidence that Morgan Stanley’s progress is sustainable, markets permitting. The improved performance of the fixed-income division is of particular note. Revenue jumped 157 percent, excluding accounting gains in last year’s third quarter, even though the unit has undergone a significant revamping since then, including laying off a quarter of its staff.

The bank, with a market capitalization of $63 billion, has cranked up its ability to generate extra revenue with its existing resources, with revenue in the third quarter rising 15 percent from a year earlier while expenses rose just 4 percent. Mr. Gorman has runway to deliver stronger returns — but he still needs the all-clear from the Fed.