Morgan Stanley Earnings Rise on Record Brokerage Revenue

Morgan Stanley reported a 35 percent increase in fourth-quarter earnings on record revenue from its brokerage, the world’s biggest. Fixed-income trading revenue was the lowest since the fourth quarter of 2008.

Net income rose to $836 million, or 41 cents a share, from $617 million, or 29 cents, a year earlier, the New York-based company said today in a statement. Earnings from continuing operations, excluding a 17-cent gain on the sale of a stake in China International Capital Corp. and a tax gain of about 6 cents, were 20 cents a share. That fell short of the 28-cent average estimate of 13 analysts surveyed by Bloomberg.

Morgan Stanley had higher investment-banking revenue than Goldman Sachs Group Inc. for the second time in the past three years and the highest brokerage profit margin since it bought a controlling stake in a joint venture with Citigroup Inc.’s Smith Barney unit in 2009. Chief Executive Officer James Gorman, 52, replaced fixed-income trading head Jack DiMaio with Ken DeRegt last week as fourth-quarter fixed-income trading revenue was less than half its rivals.

“The recovery of the market seems to be making Gorman’s bet on retail look much more achievable,” said Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York who rates the stock “outperform.” “The only issue is fixed income, and I think they have the man in the job to fix it.”

Photographer: Jin Lee/Bloomberg

Morgan Stanley CEO James Gorman has promised to reduce the portion of the company’s overall revenue awarded in compensation after it surged in 2009. Close

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Photographer: Jin Lee/Bloomberg

Morgan Stanley CEO James Gorman has promised to reduce the portion of the company’s overall revenue awarded in compensation after it surged in 2009.

Morgan Stanley rose 55 cents, or 2 percent, to $28.30 in New York Stock Exchange composite trading at 10 a.m. The stock was up 2 percent this year through yesterday.

Wealth Management

The global wealth-management division, which includes the brokerage joint venture, had $3.35 billion in revenue, up 7 percent from a year earlier, and a 12 percent pretax profit margin. The unit had $14.1 billion of net new assets, bringing the annual total to $22.9 billion and meeting Gorman’s target of more than $20 billion of inflows in 2010.

While the firm is taking steps toward Gorman’s goal of a 20 percent pretax margin by the end of this year, it remains “market dependent,” Chief Financial Officer Ruth Porat said in an interview.

“The improving pretax margin in retail is very, very good news and the promise of that 20 percent pretax margin from retail is looking more achievable in a recovering market,” Hintz said.

In the fourth quarter, Morgan Stanley’s revenue from fixed- income sales and trading was negative $29 million. Excluding gains or losses from its own credit spreads, fixed-income revenue was $813 million, compared with $1.64 billion at Goldman Sachs and $2.88 billion at JPMorgan Chase & Co.

Fixed Income

“While we made progress in building out our fixed-income business through investments in both people and technology, there is more to be done to drive revenue and market share growth,” Gorman said in the statement.

In equities trading, Morgan Stanley posted fourth-quarter revenue of $1.08 billion, up 17 percent from the third quarter and 40 percent from a year earlier. The unit’s revenue, which was $1.18 billion excluding debt-valuation adjustments, compares with $1.13 billion at JPMorgan and $808 million at Citigroup.

Morgan Stanley generated $1.52 billion in revenue from investment banking in the fourth quarter. It reaped $661 million in fees from equity underwriting, higher than any of its closest rivals.

“This is a company that’s still in transition in some of its businesses,” Charles Peabody, an analyst at Portales Partners LLC in New York, said in an interview on Bloomberg Television’s “In the Loop.” Yet in “equities and M&A, that’s where Morgan Stanley really showed some strength in the quarter and where its platform is strong.”

Goldman Sachs

Goldman Sachs fell 4.7 percent yesterday after posting fixed-income trading revenue that dropped 48 percent from a year earlier. Citigroup, which reported earnings on Jan. 18, missed analysts’ estimates as revenue from trading stocks and bonds each fell more than 40 percent from the third quarter. JPMorgan beat estimates last week as investment-banking revenue jumped 22 percent from the third quarter. All three companies are based in New York.

Overall revenue at Morgan Stanley rose to $7.81 billion from $6.84 billion a year earlier. Book value per share climbed to $31.49 from $31.25 at the end of September. The firm’s return on equity from continuing operations, a measure of how well it reinvests earnings, was 5.4 percent.

Global wealth management posted pretax income of $390 million, up from $231 million in the fourth quarter of 2009. Asset management reported a pretax gain of $356 million, compared with a $37 million pretax loss in the previous year’s period.

Compensation Expense

Compensation and benefits increased 10 percent to $4.06 billion in the quarter from the previous quarter, or 52 percent of the firm’s overall revenue. The ratio was higher than in the first three quarters, when the bank set aside 50 percent of revenue.

Gorman shook up his top management ranks as he entered his second year as CEO. Last week, he named Greg Fleming to replace Charles Johnston as president of the retail brokerage in addition to Fleming’s role in leading the asset-management business. Johnston will be vice chairman of Morgan Stanley Smith Barney until he retires at the end of 2011.

Gorman also picked deRegt, the firm’s chief risk officer, to take over for DiMaio in attempting to turn around the fixed- income trading unit. DiMaio is leaving the firm. Morgan Stanley earlier this month named Jim Rosenthal as its chief operating officer to succeed Thomas Nides, who left to take a position in the U.S. State Department.

CICC Sale

The bank said previously it recorded a gain from the sale of its 34.3 percent holding in CICC to four investors. Morgan Stanley, which invested $35 million in CICC when it was established in 1995, is forming a joint venture with China Fortune Securities Co.

The firm also booked a pretax gain of $96 million on the sale of its stake in Invesco Ltd., which it acquired through the divestiture of its retail asset-management business last year. The bank sold the stake for $664 million in November, and it carried the equity stake at a value of $568 million as of Sept. 30, according to a regulatory filing.

The firm took a $126 million charge from the sale of its controlling interest in FrontPoint Partners LLC, a hedge fund it bought in 2006. Morgan Stanley said in November it expected a pretax loss of $70 million on the sale, which leaves it with a minority stake.

Bond Spreads

Revenue was lowered by charges related to the narrowing of the firm’s own credit spreads. The company booked $5.1 billion of gains in fiscal 2008 as its bond spreads widened, then reversed them in 2009 as markets improved and spreads tightened. Overall debt-valuation costs for 2010 were $873 million.

Seven analysts cut their per-share earnings estimates in the past four weeks, with some citing weak trading markets. The average earnings estimate fell 11 cents in the past four weeks.

The company said it had a $95 million tax gain in the fourth quarter. Based on the average number of diluted shares outstanding, that equates to about 6 cents a share.

Morgan Stanley was among banks that submitted a capital plan to the Federal Reserve this month as lenders seek permission to raise dividends and buy back shares. In April 2009, the firm cut its dividend to 5 cents from 27 cents. Porat said the firm expects to hear from the Fed later in the first quarter.

Smith Barney

“When we look at deploying our capital, we’re focused on continuing to invest in our business, we’re focused on planning for the buyout of Smith Barney, and the next use of capital would be to layer in share repurchases at some point,” Porat said. Morgan Stanley has said it plans to buy the portion of the Smith Barney joint venture it doesn’t already own.

The bank is also making changes to comply with the new Dodd-Frank financial-regulation law passed last year. It plans to break off its largest proprietary-trading group, Process Driven Trading, to create an independent advisory firm by the end of 2012, and will have to trim the $4.5 billion of capital it has in private-equity, real-estate and hedge funds.

The firm finished the year as both the top underwriter of equity offerings and the top adviser on announced mergers and acquisitions globally for the first time since Bloomberg began compiling data in 1999.

To contact the reporter on this story: Michael J. Moore in New York at mmoore55@bloomberg.net.

To contact the editor responsible for this story: David Scheer at dscheer@bloomberg.net

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