March 22 (Bloomberg) -- Morgan Stanley, the second-biggest trader on Wall Street, said first-quarter earnings rose 17 percent as revenue from buying and selling stocks, bonds and commodities overcame a decline in the firm's brokerage unit.

Net income in the three months ended Feb. 28 climbed to $1.64 billion, or $1.54 a share, from $1.4 billion, or $1.29, a year earlier, Morgan Stanley said in a statement today. The profit, Morgan Stanley's second-best ever, exceeded the highest analyst estimate.

Revenue climbed 24 percent to $8.48 billion, buoyed by oil, electricity and gas trading, and Morgan Stanley's traditional strengths in equity and debt. The New York-based firm failed to match Goldman Sachs Group Inc., Lehman Brothers Holdings Inc. and Bear Stearns Cos., which reported record earnings, and Chief Executive Officer John Mack said in the statement that ``we see substantial opportunities to further improve our performance.''

``You're seeing a turnaround in the core institutional securities group,'' said Steve Roukis of New York-based Matrix Asset Advisors Inc., which owns more than 1 million Morgan Stanley shares. ``Now you want to see them turn around the brokerage business.''

Shares of Morgan Stanley, the worst-performing investment bank in the Amex Securities Broker/Dealer Index this year, rose $1.53, or 2.5 percent, to $61.94 in composite trading on the New York Stock Exchange.

Accounting Charge

The top analyst estimate for Morgan Stanley's profit was $1.41 a share, according to a survey by Thomson Financial. The average was $1.21. Morgan Stanley, the world's third-largest securities firm by market value, said net income included 4 cents a share of profit for discontinued operations.

The results underscore a divide at Morgan Stanley that has widened since Dean Witter, Discover & Co. bought the firm in 1997. While the investment bank kept pace with rivals such as Goldman, the brokerage for individual investors that Morgan Stanley inherited from Dean Witter fell further behind Merrill Lynch & Co. and Citigroup Inc.'s Smith Barney.

Last year, the brokerage became a lighting rod for criticism during the shareholder revolt that eventually forced out CEO Philip Purcell. In the first quarter, pretax profit at the division tumbled to $23 million from $353 million a year earlier.

In asset management, a division that also slipped under Purcell, profit fell 40 percent to $172 million. Results in both asset management and retail brokerage were hurt by a $395 million charge for an accounting change related to employee stock awards.

Sidwell `Pretty Optimistic'

Institutional securities, the trading and investment-banking unit that most closely resembles the old Morgan Stanley, carried the firm in the quarter with a 63 percent increase in profit to $1.75 billion. Revenue from both equity and fixed-income trading rose 36 percent, fueled by demand from hedge funds.

Chief Financial Officer David Sidwell said he's ``pretty optimistic'' about the firm's outlook even though some divisions remain laggards.

``The second quarter is looking pretty good,'' he said in a telephone interview. ``I don't think a major improvement in brokerage and asset management will be next quarter. We've said, especially in retail brokerage, that it will take some time.''

First-quarter revenue from equity sales and trading rose to $1.7 billion, the second-highest in Morgan Stanley's history, as stocks gained in the U.S., the U.K., Hong Kong and Japan. Fixed- income provided a record $2.7 billion in revenue, and Sidwell said commodities trading was ``by far the biggest driver.''

Merger fees rose 40 percent to $355 million and underwriting revenue climbed 12 percent to $548 million.

Profit Pledge

``This is a good, solid quarter,'' said Lauren Smith, an analyst at Keefe, Bruyette & Woods who has an ``outperform'' rating on Morgan Stanley shares. ``Clearly, too, they have the benefit of a really good market.''

Return on equity rose to 22.1 percent in the fiscal first quarter from 19.7 percent a year earlier. That compares with 36.4 percent for Goldman, 26.7 percent for Lehman and 20.1 percent for Bear Stearns. All three firms also are based in New York.

Mack, a former Morgan Stanley president who left in 2001, succeeded Purcell as CEO on June 30. Since taking over, he has fired more than 1,000 brokers and two dozen senior bankers and agreed to sell an aircraft-leasing unit for $2.5 billion, taking steps to meet his November pledge of doubling Morgan Stanley's profit in five years.

Discover, the credit-card division that Morgan Stanley inherited in the $10.4 billion purchase by Dean Witter, posted record pretax profit of $479 million as revenue rose 14 percent. Sidwell told analysts on a conference call that he expects ``higher loss rates'' at Discover in the second half of the year due to ``pressure'' on consumers.

Turnaround Effort

While revenue at the brokerage unit, known as Global Wealth Management, rose 4 percent to $1.3 billion, Morgan Stanley said profit fell in part because of higher compensation costs and increased legal and regulatory costs. The division also bore $80 million of the accounting charge.

Mack hired Merrill's James Gorman, 47, to turn around the brokerage unit and paid him $29.6 million in stock to join Morgan Stanley in February, mostly to replace compensation he forfeited when he quit Merrill. The unit ended the first quarter with 9,000 financial advisers, down from 10,438 before Mack joined.

During the fiscal first quarter Mack tried to expand in asset management by holding takeover talks with BlackRock Inc., the third-biggest U.S. bond investor. He also approached FrontPoint Partners LLC, a manager of hedge funds.

Acquisitions, Buybacks

``It's going to take time to build our presence in alternatives,'' Sidwell said. ``I think we're much more focused at this point on the smaller transactions.''

New York-based BlackRock ended up agreeing to merge with Merrill's money-management arm.

Today, Morgan Stanley offered to buy Denver-based TransMontaigne Inc. in a transaction that values the U.S. fuel transporter at about $421 million.

Sidwell also said Morgan Stanley now expects its planned stock buyback to be at the ``lower end'' of the $2 billion to $4 billion range it set last year. He cited the ``capital intensity'' of the securities business, where Mack has traders taking on more risk, other ``growth initiatives'' and plans for ``bolt-on'' acquisitions.

To contact the reporter on this story: Gregory Cresci in New York at gcresci@bloomberg.net.

Last Updated: March 22, 2006 16:15 EST