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Morgan Stanley Needs to Cut to the Bone: Analyst

NEW YORK (TheStreet) -- Morgan Stanley (MS) may need to speed up its plans to reduce its fixed income assets in order to generate acceptable returns for investors, according to one Wall Street analyst.

"We have begun to hear more global investment banks with sub-scale FICC [or fixed income, currency and commodities] operations choosing to de-emphasize that business," wrote UBS analyst Brennan Hawken on Monday.

Hawken said that "in the most likely scenarios, MS could improve its return on regulatory capital by 40 bps to 100 bps, even with revenue headwinds and margin compression," and that the "downside scenarios were fairly moderate if the impact of such a wind down is more severe than we expect." The analyst said that "we could see the announcement of more bold actions as a meaningful positive for MS shares."

Morgan Stanley CFO Ruth Porat at a conference on Sept. 11 said that the company planned "to drive fixed income risk-weighted assets [RWAs] to $255 billion" by the end of 2014, "or levels at least 35% below those at the end of the third quarter of 2011, subject to final rules and regulatory changes." Porat said at the September conference that "RWAs in our fixed income and commodities business... were approximately $320 billion."

Porat said during the company's third-quarter earnings conference call on Oct. 18 that "risk-weighted assets under Basel I are expected to be approximately $319 billion at September 30," and when asked for an updated on fixed income RWA reduction said that "we are very much on track for the targets that we laid out at the conference."

Morgan Stanley reported that third-quarter "Fixed Income & Commodities sales and trading net revenues were $1.5 billion compared with $1.1 billion a year ago," excluding debit valuation adjustments (DVA) and said that "the increase in net revenues from last year's third quarter reflected higher results in interest rate products and gains in credit products compared to losses in the prior year quarter." Fixed income net revenue also increased from $770 million in the second quarter.

While investors were no doubt pleased to see the rebound in fixed income revenue, Morgan Stanley's overall performance was still quite weak, with a third-quarter return on average common equity of 3.7%. Looking further at returns on regulatory capital for various business groups, Morgan Stanley's Global Wealth Management Group saw a third-quarter return on average Tier 1 common capital of 18% during the third quarter, while the return for the institutional securities group was just 6%.

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