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Morningstar | Morgan Stanley's net interest income growth has slowed, which may stall operating margin expansion.

We remain cautious on Morgan Stanley continuing its recent strong performance, as we're likely within a couple of years of the peak of this capital market cycle. At the moment, Morgan Stanley looks like it can fire on all cylinders. There’s a general view that global economic growth will continue, which should lead to a continued high level of underwriting and merger activity in the U.S. and likely growth in Europe and Asia. The company also looks like it successfully rightsized its fixed income trading business, having exceeded its $1 billion per quarter goal, and is at the top for equities trading. Higher interest rates, coupled with the growth in the company’s banking business, lead to high-margin net interest income that will propel Morgan Stanley’s wealth management segment’s operating margins higher. Additionally, the U.S. government under the current Republican administration is likely to take a more lenient stance, which could lead to increased capital returns at Morgan Stanley and other financials.The next couple of years look quite rosy, but the company will eventually reach a point where it can’t improve any further and the next step will be down. Besides a recession and general turn in the capital market cycle, there are a couple of risk factors to Morgan Stanley that differentiate it from peers. The first is that the beginning of 2019 will mark the cessation of the retention agreements that were made with Smith Barney employees at the time of the acquisition. On the positive side, the company estimates that this could lower the compensation ratio by 1 percentage point, but it also will be a time when financial advisors are more likely to leave. A second jolt of reality that could occur in the wealth management business is that its operating margin expansion story could stall or reverse with a normalization of credit costs at the bank. Credit costs are close to pristine at all banks, but Morgan Stanley investors that aren’t accustomed to viewing the company in terms of traditional banking risks may be surprised by the eventual credit cost normalization.