With margins at its retail-brokerage business running at just half of what it promised investors, Morgan Stanley is slashing costs and turning up the pressure on low-end representatives to become more productive.
“The margin is not where we'd like it,” Ruth Porat, Morgan Stanley's chief financial officer, said at a Deutsche Bank AG conference in New York last week.
The pretax profit margin at the firm's wealth management joint venture with Citigroup Inc. — Morgan Stanley Smith Barney LLC — was just 10% at the end of the first quarter, far from the 20% level that chief executive James Gorman set as a target when he took the reins of the firm early last year.
The numbers also don't please Wall Street analysts, who clearly are disappointed with the pace of the integration of the Smith Barney retail business.
“I would have thought they'd have the system convergence done by now,” said Jeff Harte, a principal and analyst with Sandler O'Neill + Partners LP.
He has lowered his 2011 earnings estimate to 97 cents a share, from $1.15, but is maintaining a “buy” rating on the stock. Morgan Stanley shares have dropped by about 20% this year.
The move to a single technology platform, from three, represents a large part of the annual $1 billion in cost savings that the firm hopes to achieve by 2014. Legacy Morgan Stanley financial advisers will be the first to move to the new system in the third quarter, and legacy Smith Barney advisers will join them by the middle of next year, Ms. Porat said.
Because back-office and platform integration won't get the firm all the way to the profitability it seeks, she indicated that MSSB also will look to make further cuts in the adviser ranks.
“We may reduce our broker head count below previously announced targets,” Ms. Porat said.
The previous target was 17,500 advisers — 300 fewer than the number at the end of the March quarter, meaning that more large-scale firings could happen this year. The firm axed close to 300 trainees and low-producing advisers in one fell swoop last quarter.
Head count reductions also will come from the continuing consolidation of the firm's branch network. MSSB closed 19 retail locations in the first quarter, leaving it with 832 offices across the country, down from 905 at the end of the first quarter of last year.
For large firms looking to become more productive, reducing occupancy costs can be meaningful. UBS Financial Services Inc., for example, unloaded 55 small branch offices to Stifel Financial Corp. in 2009, as much for the cost savings as for the $27 million that Stifel paid.
“Real estate is a big expense for firms,” said Andy Tasnady at compensation consultant Tasnady Associates LLC. “If a branch office loses advisers, the fixed costs of maintaining it are still largely the same.”
With the departure of a large number of Smith Barney managers during the past year, the consolidation of branch offices will continue.
“We are not withdrawing from any markets, but we will continue to look for opportunities to consolidate locations where we have excess capacity and leases expire,” said MSSB spokeswoman Christine Pollak.
At 62% of revenue in the first quarter, compensation and benefits represent the biggest potential source of cost savings for the wealth management division. But big producers almost certainly won't be affected.
“The demand for high-end producers is still very strong,” Mr. Tasnady said. “When firms focus on compensation costs, they don't want it to reduce their sales levels.”
But for reps that produce significantly less than the $767,000 in revenue achieved by the average MSSB adviser at the end of the first quarter, the pressure is likely to pick up.
“Firms are always trying to do things to slow down [compensation] grid creep,” Mr. Tasnady said. “They might raise the bar for low-end producers or they may lower the payout.”
There is no required-minimum-production level at MSSB, according to Ms. Pollak, but “penalty box” pay is bad. Brokers with more than eight years' experience who generate less than $250,000 in revenue receive a payout of just 20%.
With senior management focused on the bottom line, brokers probably won't be allowed to remain in the penalty box for long.
E-mail Andrew Osterland at aosterland@investmentnews.com.
