NEW YORK — Morgan Stanley chief executive James Gorman told investors that the company could delay plans to purchase part of the 49% stake in brokerage firm Morgan Stanley Smith Barney that it doesn't already own.
The comments, made Friday during a private meeting with about 10 investors at the company's New York headquarters, show how hard Morgan Stanley is trying to keep its financial options open as it mulls how to boost capital ratios ahead of heightened global standards that take effect in 2013.
Morgan Stanley still intends to buy the rest of the 18,000-broker joint venture from former Smith Barney owner Citigroup Inc. by 2014 as originally planned, a spokeswoman for the firm said. But Morgan Stanley may not stick to the fastest-possible timetable under the plan, which has it buying the 49% stake in three installments starting in May 2012.
Gorman, who started as CEO at the beginning of the year, told investors at a meeting Friday that Morgan Stanley has the flexibility to delay part of the purchase if it wants to, according to people familiar with the session. One of the main reasons it may wait: to conserve capital to keep its ratios higher as new rules go into effect under the Basel III international accords
The Basel III rules, designed to make banks safer, will be more fully disclosed later this month. The looming rules are part of a regulatory wave that is forcing banks throughout the world to rethink business lines and delay some growth plans.
Friday's meeting was sponsored by Nomura Securities analyst Glenn Schorr, who wrote in a research report Tuesday that "a longer buy-in timeline for the remaining 49% of Morgan Stanley Smith Barney...would allow for better capital flexibility to deal with Basel III."
Analysts have said they expect Morgan Stanley to have enough capital for the new Basel rules because of earnings the company can retain and assets it can sell between now and 2013.
Still, Morgan Stanley and other large financial firms might face added restrictions on their capital because they are so large that their possible demise could cause a rerun of the financial panic of 2008.
Given Morgan Stanley's current assets, the firm's so-called Tier 1 common capital ratio under the new rules would stand at about 7.5%, assuming the company is successful in delivering a projected $100 billion in asset sales and other steps to help the balance sheet. Regulators have set the base ratio at 7%, but it is likely to be higher for large firms like Morgan Stanley.
As a result, Morgan Stanley might have to look for ways to increase its capital ratio just as it is allowed to start buying more of the brokerage joint venture.
Morgan Stanley currently controls the venture and owns 51% of it, while Citigroup owns 49%. Under the agreement between the two companies, Morgan Stanley can buy another 14% of the joint venture starting in 2012, 15% the following year and 20% in 2014.
Morgan Stanley also can delay the purchase, though Citigroup can force Morgan Stanley to buy the rest of the stake if Morgan owns 80%, according to people familiar with the matter.
Gorman has staked a chunk of the 75-year-old securities firm's future on the retail-brokerage business. In 2009, Morgan Stanley's finance chief at the time, Colm Kelleher, said the firm planned to finish the transaction in three to five years.
But during the company's third-quarter conference call Oct. 20, Schorr asked whether Morgan Stanley was obligated to buy the stake in three to five years.
Gorman and Chief Financial Officer Ruth Porat responded that the company had an option to buy the rest of the company, but neither executive reiterated the company's desire to do so. "It's an open-ended call option," said Gorman.
Federal regulators want the company to keep its capital ratios high, especially because it came close to the brink of death in 2008. Falling below certain capital levels could bring on tougher regulations and restrictions on pay.
Morgan Stanley is looking at other steps to conserve capital, including keeping dividends low and avoiding stock buybacks. Holding off on the Smith Barney stake is viewed as less likely to occur.
Such a move would save an estimated $1.9 billion in 2012, $2 billion in 2013 and $2.6 billion in 2014, though that could fluctuate with the market value of the business. Overall, the company could save an additional 0.3% to 0.4% on the capital ratios by not buying the first stake in 2012.
Delaying part of the Smith Barney deal for a year or two likely wouldn't upset brokers or investors, though some may grumble if it hurts expected cost savings, said Jeff Harte, an analyst with Sandler O'Neill.
Meanwhile, Morgan Stanley's capital could get a big boost if Japanese bank Mitsubishi UFJ Financial Group Inc. converts about $7.8 billion in preferred shares it owns in Morgan Stanley to common stock.
Under the terms of Morgan Stanley's deal with MUFG, that can happen only if Morgan Stanley's share price rises more than 50% from current levels.
Some observers say any change in the Smith Barney timetable could be viewed as a sign of weakness, because Morgan Stanley has repeatedly said it wants to be bigger in wealth management.
With more than 18,000 financial advisers, the joint venture is a key part of Morgan Stanley's strategy to provide stable revenue growth, while cutting $1.1 billion in costs to boost profit margins.
The company originally forecast $14 billion in revenue from the combined entity, along with a 20% pretax profit margin. Meeting those goals is taking longer than originally expected, partly because of choppy markets and defections of Smith Barney brokers in the months following the deal's announcement in 2009.
In the five quarters since the deal was completed, Morgan Stanley Smith Barney has lost more than twice as many domestic assets as it has gained, though the firm reported net asset inflows in two of the last three quarters.
Revenue has climbed modestly, reaching $3.1 billion in the latest quarter, up 2% from a year earlier. Morgan Stanley is about halfway through integrating the operations, including building a new technology platform.
"Investors are looking at the purchase as a when not an if," said Sandler O'Neill's Harte. Still, he adds, "it's not an easy home run that they have the capital" to buy it as quickly as the contract allows.