Morgan Stanley Shares Rise as Earnings Beat Estimates, MUFJ Converts Stake

Morgan Stanley, operator of the world’s largest brokerage, rose in New York trading after reporting profit that beat analysts’ estimates and saying a Japanese bank agreed to convert a preferred stake in the firm.

First-quarter net income was $968 million, or 50 cents a share, and adjusted earnings of 46 cents topped analysts’ average estimate of 40 cents. Net income included a 26-cent loss tied to a joint venture with Mitsubishi UFJ Financial Group Inc., which agreed to convert $7.8 billion of preferred stock and eliminate $784 million in annual dividend payments for Morgan Stanley.

Trading revenue almost tripled from the fourth quarter, bolstering Chief Executive Officer James Gorman’s efforts to rejuvenate the New York-based firm’s fixed-income business, which generated less than a third of the revenue Goldman Sachs Group Inc. produced in the past two years. MUFG’s conversion will add about 2.7 percentage points to Morgan Stanley (MS)’s Tier 1 common ratio and eliminates what Gorman, 52, called the “No. 1” uncertainty for the firm.

“There’s evidence of improvement in their trading operations, especially with equity trading, which was very strong,” said Shannon Stemm, an analyst with Edward Jones & Co. in St. Louis who rates the stock “buy.” “The conversion improves their capital position, and it removes those preferred dividend payments. So while the share count will go up, it adds some flexibility.”

Share Performance

Morgan Stanley rose 44 cents, or 1.7 percent, to $26.48 at 4:15 p.m. in New York Stock Exchange composite trading. It earlier jumped as much as 5.2 percent, the biggest intraday climb since January. The stock was down 4.3 percent this year through yesterday, after falling 8.1 percent in 2010.

Earnings fell 45 percent from the $1.78 billion the firm reported in last year’s first three months, when Wall Street posted the best fixed-income trading quarter since the financial crisis. Earnings from continuing operations, excluding the 26- cent joint venture loss and a 30-cent tax gain, beat the average estimate of 14 analysts surveyed by Bloomberg.

Mitsubishi UFJ Morgan Stanley Securities Co., which is 40 percent owned by Morgan Stanley, said today it will cut jobs and raise capital after posting a loss of 145 billion yen ($1.8 billion) last year that was fueled by wrong-way bets on fixed- income products.

‘Committed’ to Japan

“While the loss at our joint venture with MUFG is disappointing, we remain strongly committed to the Japanese market and our strategic partners at MUFG,” Gorman said in the statement. “This loss does not impact the progress we are making in pursuing our own strategic priorities.”

Mitsubishi UFJ will exchange the convertible preferred stake, which had a 10 percent dividend, for 385 million shares of Morgan Stanley common stock. That included 75 million additional shares Morgan Stanley agreed to issue in order to reach the agreement.

The move provides Mitsubishi UFJ with a 22 percent ownership interest in the U.S. investment bank and a second seat on its board of directors. Mitsubishi UFJ still holds $500 million of non-convertible preferred stock with a 10 percent dividend.

Goldman Sachs fell 1.3 percent on April 19 in New York trading after first-quarter profit declined 21 percent and analysts said the bank relied on unpredictable investment gains to beat estimates. JPMorgan Chase & Co. (JPM) exceeded estimates last week as investment-banking revenue jumped 33 percent from the fourth quarter. Both companies are based in New York.

Book Value

Revenue at Morgan Stanley dropped to $7.64 billion from $9.07 billion a year earlier. Book value per share fell to $31.45 from $31.49 at the end of December. The firm’s return on equity from continuing operations, a measure of how well it reinvests earnings, was 6.2 percent.

In the first quarter, Morgan Stanley’s revenue from fixed- income sales and trading was $1.77 billion, compared with negative revenue of $29 million in the fourth quarter and $2.72 billion in the first quarter of 2010. Excluding gains or losses from its own credit spreads, fixed-income revenue was $1.93 billion, compared with $4.3 billion at Goldman Sachs and $5.2 billion at JPMorgan.

Gorman said in February that his “No. 1” priority is turning around the firm’s fixed-income trading unit, hoping to capture a 2 percentage-point gain in market share this year. Excluding gains and losses tied to their own debt, Morgan Stanley had about a 6 percent market share in 2010 among 11 of the largest U.S. and European banks, according to data compiled by analysts at JPMorgan and Nomura.

DiMaio, deRegt

Gorman replaced fixed-income trading head Jack DiMaio with Ken deRegt, and the firm hired Glenn Hadden from Goldman Sachs as global head of interest rates.

“This is the first time that I have felt comfortable with the leadership across all of our fixed-income businesses,” Gorman said on a conference call with analysts. “You’ve got to have that ability at the top and the investment we made in hiring people combined with the leadership at the top is what has moved the needle.”

Morgan Stanley is looking to gain market share in rates, where it increased staff by about 20 percent, and foreign exchange, where it added 40 percent more people, Gorman said in February.

The firm saw “particular strength” in those areas in the first quarter, Chief Financial Officer Ruth Porat said in an interview today.

MBIA Hedges

Hedges against exposure to bond insurers including MBIA Inc. resulted in net losses of about $318 million, which were included in fixed-income results. Porat said today that the hedges are “not closed out” and said some of them have been “adjusted.”

In equities trading, Morgan Stanley’s first-quarter revenue rose to $1.7 billion, up 57 percent from the fourth quarter and 20 percent higher than a year earlier. The unit’s revenue compares with $2.3 billion at Goldman Sachs and $1.4 billion at JPMorgan.

“We think Morgan’s investment bank posted solid results, with clear improvement in trading, particularly in equities,” Glenn Schorr, an analyst at Nomura Holdings Inc., wrote in a note to investors. “Trading improvement is one of the clear issues investors have been waiting for.”

Morgan Stanley generated $1.01 billion in revenue from investment banking in the quarter, up 14 percent from a year earlier. That included $385 million from financial advisory, $285 million from equity underwriting and $338 million from debt underwriting.

Merger Rankings

The firm was the second-ranked adviser on mergers announced in the quarter, as well as the fourth-ranked underwriter of stock offerings, according to data compiled by Bloomberg. It finished 2010 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.

Global wealth management, which includes Morgan Stanley’s brokerage joint venture with Citigroup Inc.’s Smith Barney, posted pretax income of $348 million, up from $278 million in the first quarter of 2010. The division’s pretax profit margin fell to 10 percent from 12 percent in the fourth quarter. The unit had $11.4 billion of net new assets.

Asset management reported a pretax gain of $127 million, compared with $174 million in the previous year’s period.

Compensation and benefits decreased 2 percent from the year-earlier quarter to $4.33 billion, or 57 percent of the firm’s overall revenue. The ratio was higher than in the first quarter of 2010, when the bank set aside 49 percent of revenue.

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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