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Gorman Gains on Blankfein in Bet on Brokerage: Credit Markets

Morgan Stanley CEO James Gorman
James Gorman, chairman and chief executive officer of Morgan Stanley, is winning bondholders’ confidence by cutting the firm’s reliance on trading businesses that posted a 52 percent decline in revenue last year and shifting the firm’s focus to its steadier brokerage unit. Photographer: Scott Eells/Bloomberg

Morgan Stanley’s reputation as Wall Street’s weakest link is diminishing in debt markets as Chief Executive Officer James Gorman’s bet on a brokerage unit that has amassed $1.78 trillion in client assets starts to pay off.

The cost of credit-default swaps protecting investors against losses on Morgan Stanley’s debt is about the lowest relative to the bank’s peers in almost two years, with the gap between it and its closest rival, Goldman Sachs Group Inc., narrowing to 14 basis points from as wide as 111 last year, prices compiled by Bloomberg show. The extra yield investors demand to own Morgan Stanley bonds instead of Treasuries fell by more than half in the past year to 160 basis points.

Gorman is winning bondholders’ confidence by cutting the firm’s reliance on trading businesses that posted an 8 percent decline in adjusted revenue last year and shifting the firm’s focus to its steadier brokerage unit. Pretax profit in that division increased almost 50 percent in the first quarter while fixed-income sales and trading revenue dropped the most among the bank’s peers.

“The brokerage business has been the bright spot,” Marc Pinto, head of corporate bond strategy at New York-based Susquehanna International Group LLP, said in a telephone interview. “They’ve been putting a lot of resources into that business, and it’s yielding fruit.”

Smith Barney

Morgan Stanley agreed in September to buy Citigroup Inc.’s remaining stake in the brokerage joint venture, a deal approved last month by the Federal Reserve. The bank said in January it will pay $4.7 billion to buy the rest of the Smith Barney business, which was created in 2009.

Revenue at the brokerage made up 51 percent of all sales last year, compared with 28 percent in 2008, according to data compiled by Bloomberg. That’s encouraged bond investors with the wealth-management division’s consistent “stream of fees,” said Pri de Silva, a banking analyst at New York-based debt-research firm CreditSights Inc.

“It’s a much steadier form of income, compared to the more volatile sales and trading business,” de Silva said in a telephone interview.

Narrowing Gap

Credit swaps on Morgan Stanley have fallen the most among the largest U.S. banks, dropping 304 basis points from a 2012 peak on June 4 to 150.5 basis points yesterday, Bloomberg prices show. That’s about 33 basis points more than the average of credit swaps tied to the six-biggest U.S. banks, from JPMorgan Chase & Co. to Goldman Sachs, run by Chief Executive Officer Lloyd C. Blankfein, the data show. The gap has narrowed from as wide as 175 basis points in May 2012.

Mark Lake, a spokesman for Morgan Stanley, declined to comment on the market moves.

Elsewhere in credit markets, the cost to protect corporate debt from default in the U.S. fell for the first time in three days. Charter Communications Inc., the fourth-largest U.S. cable operator, was said to have set the rate it will pay on a $1.2 billion loan to repay debt and is planning to issue $1 billion of bonds.

The U.S. two-year interest-rate swap spread, a measure of debt-market stress, fell 0.11 basis point to 13.75 basis points as of 11:48 a.m. in New York. The gauge, which has dropped from a seven-month high on March 29, narrows when investors favor assets such as company bonds and widens when they seek the perceived safety of government securities.

Credit Benchmarks

The Markit CDX North American Investment Grade index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, declined 1.2 basis points to a mid-price of 84 basis points, according to prices compiled by Bloomberg.

In London, the Markit iTraxx Europe index of 125 companies with investment-grade ratings declined 0.8 to 113.5.

The indexes typically fall as investor confidence improves and rise as it deteriorates. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Bonds of Fairfield, Connecticut-based General Electric Co. are the most actively traded dollar-denominated corporate securities by dealers today, accounting for 6.5 percent of the volume of dealer trades of $1 million or more, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Charter Loan

The term F portion of Charter’s loan will come due in January 2021 and pay interest at 2.25 percentage points more than the London interbank offered rate, with a 0.75 percent minimum on the lending benchmark, according to a person with knowledge of the transaction, who asked not to be identified because the information is private. Charter is offering the loan to investors at 99.75 cents on the dollar.

Charter, through its CCO Holdings LLC and CCO Holdings Capital Corp. units, also is planning to sell senior unsecured notes due in 2024, the Stamford, Connecticut-based company said today in a statement distributed by PR Newswire.

Morgan Stanley, which was seen as less creditworthy than some Italian lenders two years ago, now has one of the highest liquidity-reserve levels among the biggest banks. The lender estimated its coverage ratio of more than 125 percent in February, topping Citigroup’s 118 percent and UBS AG’s 113 percent, data compiled by Bloomberg show.

Stocks Diverge

The extra 160 basis points of yield investors demand to own Morgan Stanley debt instead of Treasuries is 7 basis points wider than the average spread for U.S. banks, according to the Bank of America Merrill Lynch U.S. Banking index data. The gap was 139 basis points a year ago.

“We’ve seen a considerable amount of compression in bank spreads as they de-lever their balance sheets,” Ashish Shah, the head of global credit investment at New York-based AllianceBernstein Holding LP, which oversees $256 billion in fixed-income assets, said in a telephone interview.

Equity investors aren’t as encouraged, sending Morgan Stanley shares to the lowest level in three months yesterday after reporting fixed-income trading fell 42 percent, the most among the largest U.S. banks last quarter. The shares, which were up 6.2 percent this year, fell 5.4 percent to $20.31 in New York trading yesterday.

Bank Conversion

Morgan Stanley’s price to tangible book value, a measure of a company’s net worth, is 0.80 per share, trailing Goldman’s 1.03 times.

Morgan Stanley and Goldman Sachs were converted to bank holding companies in September 2008 amid the worst financial crisis since the Great Depression, giving the Fed regulatory oversight over the firms and allowing them to increase funding through deposits.

Morgan Stanley borrowed $107.3 billion, the most of any bank, from the Fed in September 2008, according to data compiled by Bloomberg News in 2011.

“A lot of investors have seen Goldman as the golden child and treated it as such,” Jody Lurie, a corporate credit analyst at Janney Montgomery Scott LLC in Philadelphia, said in a telephone interview. Now that Morgan Stanley is going to own all of Smith Barney, “it’s signaling that you should be able to see a better growth story from them.”

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