BAC Bank of America Corporation

By Liz Hoffman 

Morgan Stanley in 2009 was worth $50 billion less than its longtime rival, Goldman Sachs Group Inc. After reporting strong earnings on Wednesday, Morgan Stanley has nearly closed that gap.

The surprising turnabout between the two rivals shows just how much has changed on Wall Street since the financial crisis: Boring is beating swashbuckling.

Goldman's strengths -- making market bets and serving hedge funds -- have been zapped by new regulations and investors' aversion to risk. Morgan Stanley, meanwhile, has cut traders and trained those who remain to take fewer risks, while adding to businesses that make money reliably and aren't penalized by capital rules.

The quarter was challenging for the industry as trading sputtered and loan growth stalled in spots. All six of the big banks beat analysts' earnings expectations, but they sometimes required the help of noncore businesses such as private investing. Shares of Bank of America Corp. fell after its earnings release on Tuesday as investors fretted about net interest income falling from the first quarter due in part to lower long-term bond yields. And J.P. Morgan Chase & Co., while reporting record profit, trimmed its outlook for the second half.

Morgan Stanley's results had no such caveats, with contributions spread evenly among its traders, investment bankers and stockbrokers.

It has been a remarkable run for the bank and its chief executive, James Gorman, who in 2010 took the reins of a firm humbled by the financial crisis and strategically adrift. His decision to de-emphasize trading and embrace wealth management -- a business he once ran for Morgan Stanley -- has paid off, producing steady growth and winning over investors who had stayed away after repeated burns.

"These changes don't happen quickly, they happen over many years," Mr. Gorman said Wednesday. "Much of it came together in this quarter. I wouldn't run a victory lap around it yet, but this is proof of the model."

Morgan Stanley's shares rose 3.3%, bringing the firm's market value to $86.2 billion, compared with Goldman's $87.7 billion. Also contributing to the narrowing gap this week was a sharp drop in trading reported by Goldman on Tuesday.

In some ways, both firms aren't the top players they once were. The two are now eclipsed in trading revenue by J.P. Morgan, Citigroup and Bank of America, which have used their sheer size to dominate the new high-volume, low-margin trading landscape.

The two rivals, having spent decades dueling as private partnerships, came through the financial crisis as the only two large stand-alone investment banks to survive. But Goldman emerged stronger and stuck to the strategy that made it the most envied trader on Wall Street, even while peers like J.P. Morgan Chase and Bank of America bulked up.

Morgan Stanley decided it had to evolve, buying Citigroup Inc.'s Smith Barney brokerage and slashing trading businesses. The firm didn't catch up to Goldman quickly, slowly closing the gap first in revenue and then in profitability.

For the quarter, Morgan Stanley reported a profit of $1.8 billion on revenue of $9.5 billion, both up from the year-earlier period and better than analysts had expected.

While the second half of the year may prove tougher, the first half has been a validation of Mr. Gorman's reshaping of a firm he joined relatively late in his career. A former management consultant brought over from Merrill Lynch in 2007 to run wealth management, he ascended to the corner office after the crisis humbled Morgan Stanley's trading desk, and then-CEO John Mack, a former bond salesman, retired.

In 2009, Mr. Mack and Mr. Gorman struck the deal to buy Smith Barney. The purchase added heft to Morgan Stanley's wealth-management business, which remained hobbled by a tumultuous 1997 merger with Dean Witter. In 2009, the business made a profit of about $280 million. This year, it is on track for $4 billion, with remarkably steady revenue. On 98% of days in 2015, the unit bringing in between $50 million and $70 million.

That predictability is an antidote to more-volatile trading business, which the firm has been shrinking. Last year, Mr. Gorman and top lieutenant Colm Kelleher, a former trading chief, fired 25% of fixed-income traders and slashed the capital available to the unit for bets.

Still, that division -- which trades everything from corporate bonds to oil to interest-rate swaps -- has kept revenue from falling sharply. It has made more than $1 billion in revenue for five straight quarters, hitting a goal Mr. Gorman set last year.

On Wednesday, Morgan Stanley reported $1.2 billion in revenue from the division, outperforming Goldman for the second straight quarter thanks to strong trading in currencies and corporate debt.

Including Morgan Stanley's stock traders, the firm reported trading revenue for the quarter of $3.2 billion compared with Goldman's $3.1 billion.

During the first half, Morgan Stanley's overall trading revenue surpassed Goldman's for the first time since at least the financial crisis.

Part of the story is that Goldman has stumbled. Its traders, once dominant on Wall Street, are struggling to find their footing amid sweeping market changes since the crisis. Trillions of dollars have shifted to passive funds, and then came a down spell for hedge funds as well as a long stretch of calm in the markets -- all of which have reduced demand for the complex products that are Goldman's signature.

On Tuesday, Goldman reported trading revenue that fell 17% from a year earlier, the worst start to a year in CEO Lloyd Blankfein's 11-year tenure. Fixed-income revenue fell 40%. Shares tumbled 2.6% on Tuesday and another 0.2% Wednesday.

Goldman has acknowledged challenges at trading business, with its Chief Financial Officer R. Martin Chavez saying in a conference call that the firm "didn't navigate the market as well as we want to," over the past year or so. It has added new clients and businesses to be more resilient in different market conditions.

Morgan Stanley, though, has tried to avoid trading mistakes while leaning heavily on its wealth-management business. That unit reported a record $4.2 billion in revenue and hit a 25% profit-margin target, the high end of a range set by Mr. Gorman.

"There were plenty of skeptics" on Morgan Stanley, said Devin Ryan, an analyst with JMP Securities. "They've been proving naysayers wrong."

Write to Liz Hoffman at liz.hoffman@wsj.com

(END) Dow Jones Newswires

July 19, 2017 20:33 ET (00:33 GMT)

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