[ by Larry Goldfarb ]

Morgan Stanley may continue cutting assets in its fixed-income business for another five years as it seeks higher returns  According to Howard Chen, a Credit Suisse Analyst, Morgan Stanley must:

• return capital freed up by the reductions to shareholders,
• buy the rest of its brokerage joint venture
• lower its funding and operating costs.

Achieving those goals can allow the firm, which will probably produce a 5% return on tangible equity this year, to earn a 9 percent ROTE even without an improving environment, Chen said.

Chief Executive Officer James Gorman pledged to improve returns as his bank’s stock has lagged below its book value for more than two-and-a-half years. Gorman, 54, said in October that it didn’t take “heroic assumptions” to see how his plans will get the New York-based firm’s returns to its cost of capital, usually estimated at around 10 percent. “We believe franchise restoration, healthier market conditions and the absence of new negatives from here should drive further share-price outperformance,” Chen wrote. “Further proof points and effectuation of the ROTE expansion plan, with hopefully a better revenue backdrop, will drive a re- rating of Morgan Stanley (MS) shares from still depressed valuations.”

Morgan Stanley has laid out a plan to cut risk-weighted assets in its fixed-income business, which were $390 billion a year ago, to $255 billion by the end of 2014, under Basel III rules. The firm will probably continue to wind down “longer- duration exposures” for years after that to arrive at less than $200 billion by 2017, Chen said.

For more information, [Bloomberg, 12/12/13].