MSSB's 20% margin a pipe dream?

James Gorman, the former Merrill Lynch & Co. Inc. executive now leading Morgan Stanley, is finally getting some results and some credit on Wall Street. After reporting second-quarter earnings that substantially exceeded expectations yesterday, shares in Morgan Stanley surged more than 11% and Rochdale Securities LLC analyst Richard Bove went so far as to call Morgan Stanley the “new Goldman Sachs.” Morgan Stanley's financial results across its businesses were indeed impressive, particularly given the disappointing results that The Goldman Sachs Group Inc. reported two days earlier. Net revenue of $9.3 billion was a 17% jump from the comparable quarter last year, topping Goldman's sales for the first time since the end of the financial crisis. And ignoring the approximately $1.7 billion bath Morgan took to convince Mitsubishi UFJ Financial Group Inc. to convert preferred shares in Morgan Stanley to common stock, the firm would have earned $1.2 billion in the quarter. The Morgan Stanley Smith Barney LLC wealth management division, however, continues to fall far short of Mr. Gorman's expectations. Net revenue of $3.48 billion was up 1% over the first quarter, but profits were down 7% to $322 million. The pretax margin profit margin slipped a point to 9% from last quarter. That's nowhere near the 20% target that Mr. Gorman has set for the business -- a target he reaffirmed in an analyst call on Thursday. The still hypercompetitive market for financial advisers is one big reason for the shrinking margin. Compensation and benefits in the division rose 1% in the quarter to $2.15 billion. That's 9% higher than the comparable quarter last year, despite the fact that the firm reduced its ranks of global representatives to 17,638, from 18,087. As a group, the advisers increased their productivity, with each rep bringing in $785,000, versus $767,000 in the first quarter and $679,000 in the second quarter last year. The firm manages $1.7 trillion — down 1% in the quarter, and it took in $2.9 billion in net new client assets. These are respectable numbers, given the difficult markets in the second quarter. But it's clear that getting to a 20% pretax margin is going to be extremely difficult for Mr. Gorman and his lieutenants. It's been more than two years since the MSSB joint venture was created, and the integration of the two businesses remains a work in progress. The firm should see some operational savings from the migration of legacy Morgan Stanley and Smith Barney brokers to a single new technology platform starting this fall. And the firm has given notice that it will continue to cull low-end producers from the adviser ranks. But still — 20%? “I think a 20% margin is a stretch for almost any financial business,” Mr. Bove said. “Sometimes asset management firms can get there, but I don't think any wealth management companies can.” A call to MSSB seeking a comment about Mr. Bove's opinion was not immediately returned. And despite, Mr. Bove's doubts about the 20% target, he expects MSSB's strategy of reducing head count and focusing on wealthy clients eventually will bring them closer to the goal. “[Mr. Gorman's] strategy has been about more than just cutting costs; he's changing the way they do business,” said Mr. Bove. “The guy has done a phenomenal job.” At least for this quarter.