Gorman's Morgan Stanley Is Catching Up to Wells Fargo -- You May Want In

NEW YORK (TheStreet) -- The environment for banking has changed. Although the Obama administration seems to wish for more frothy financial markets than exist today, that doesn't seem to be the world we are living in. (For more of my view on this, take a look at "Yellen's Dilemma," posted earlier this week.)

James Gorman, the chairman and chief executive officer of Morgan Stanley (MS), is betting that the financial markets will not return to the period of volatility and financial innovation that existed before the financial collapse that began in the fall of 2007. While other large banks continue to rely on the business model that seemed to work in earlier years, Gorman wants to return Morgan Stanley to a more fundamental basis.

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Other large institutions continue to focus on FICC -- the revenues from fixed-income products, currencies and commodities, which produce results that can swing quite violently from quarter to quarter. But Gorman is creating a culture at Morgan Stanley that emphasizes wealth management and the more stable parts of investment banking like advisory services for mergers and acquisitions and securities underwriting.

For an irreverent look at FICC and the bank emphasis on trading, look at the column by Gary Silverman in the Financial Times, "All This Talk of FICC Is Making Me Sick."

Morgan Stanley still has a long ways to go to become an exceptional performer once again, but it is on the way.

In the second quarter of 2014, Morgan Stanley earned a 7.3% return on equity. This is above the results from a year ago, when it returned 4.4% on equity.

Like most large organizations in the banking system, Morgan Stanley's return on equity took a real hit during the financial crisis -- dropping below a 15% (or more) return in 2006 and before. It has remained below that mark up to the present.

Gorman's focus is on getting the bank up to a 10% return on equity next year.

I believe that he is on the right track to accomplishing this goal. Here's why.

Debt underwriting rose by 26% over a year ago, and the increase in equity underwriting exceeded competition. Revenues from the mergers and acquisitions business rose by 25%.

Furthermore, the firm is getting close to its goal on the profit margin earned from the wealth management business. In the last quarter, Morgan Stanley posted a 21% profit margin, whereas Gorman is looking to bring this up to the 22% to 25% range.

Finally, operating expenses continued to fall, dropping to $1.5 billion from $1.6 billion in the previous quarter.

Moving into the future, news came out from Standard and Poor's Leveraged Commentary and Data that Morgan Stanley, after it announced its strong second quarter performance, was going to offer new five-year debt to the market.

This is consistent with what many other large global banks have been doing. According to Dealogic, total sales of bank debt this year has risen to a 50% increase over 2013 levels. Driving this increase are the current very low interest rates and the almost universal belief that longer-term interest rates will be rising over the next year or two.

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Morgan Stanley looks like it preparing for continued growth in its fundamental business and wants to be prepared.

Morgan Stanley is a worthwhile company to follow at this time, and its CEO Gorman and his management team have moved their institution in the right direction. It is not in the place that Wells Fargo (WFC), for example, is in -- earning over 14% on shareholder equity.

However, if the banking and economic environment has changed and governmental policy remains relatively benign in the waning years of the Obama administration, I believe that Morgan Stanley will return to the levels of performance it was earning in the early 2000s. Those earnings exceeded a 15% return on equity.

At the time of publication, the author held no positions in any of the stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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