Is Morgan Stanley's Shrinkage A Good Thing?

• Morgan Stanley MS will reportedly be cutting 25 percent of its FICC unit.
• The move is likely an effort to boost the firm’s ROE.
• Macquarie estimates that the cost savings from the move could boost EPS by 3.0 percent.

In a new report, Macquarie analyst David Konrad discusses the Wall Street Journal report that Morgan Stanley may be cutting 25 percent of its fixed income instruments, currencies and commodities (FICC) unit. Although Macquarie sees the potential move as a positive for Morgan Stanley, the firm prefers other big bank stocks at the moment.

Smaller is better
According to Konrad, Morgan Stanley’s FICC business has been a damper on its return on equity (ROE) and its valuation. There appears to be no end in sight to the challenging trading environment, and Konrad believes that reducing the size of the FICC unit is Morgan Stanley’s attempt to dial back the units negative impact on ROE.

“Although it is challenging to estimate the appropriate size of Morgan’s FICC desk given needs to cover technology spend, support DCM and prime brokerage, we believe it is a positive for Morgan to shrink FICC exposure and costs given the material drag on ROE,” he explains.

Is it enough?
Unfortunately, the size of the cuts that the Wall Street Journal reported will likely not make a material impact on ROE. Konrad estimates that the cost savings from a 25 percent FICC cut would be about $525 million, which could potentially lift EPS by about 3.0 percent.

Outlook
Macquarie’s updated sum-of-the-parts valuation for Morgan Stanley now stands at $35/share. The firm maintains its Neutral rating on the stock.

Instead, Macquarie prefers Outperform-rated big banks Citigroup Inc C and JPMorgan Chase & Co. JPM.

Disclosure: the author holds no position in the stocks mentioned.