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Morgan Stanley Shares Decline After Earnings Tumble 50%

Morgan Stanley (MS) fell in New York trading after reporting a 50 percent drop in earnings on the biggest decline in trading revenue among Wall Street firms. The company said it will cut headcount by 4,000 this year.

Morgan Stanley slid 5.3 percent to $13.25, the biggest decline since March 6, after second-quarter net income decreased to $591 million from $1.19 billion a year earlier. The stock’s 12 percent fall this year is the largest among the 10 biggest U.S. banks.

The 48 percent drop in trading revenue, which plunged to the lowest level since Chief Executive Officer James Gorman, 54, took over in January 2010, compares with an increase of more than 11 percent at Goldman Sachs Group Inc. Clients shied away from doing business with the firm while Moody’s Investors Service weighed a credit-rating downgrade, Morgan Stanley said.

The fixed-income results were “very weak,” said Charles Peabody, an analyst at Portales Partners LLC in New York who rates the stock sector perform. “Strength tends to beget strength and weakness weakness, so I think on the fixed-income side they’re going to end up being a loser.”

Excluding accounting adjustments, profit was 16 cents a share, below the 29-cent average estimate of 20 analysts surveyed by Bloomberg. On that basis, the firm’s return on equity was about 2 percent, below Gorman’s goal of 15 percent.

Mayo’s Upgrade

Morgan Stanley shares pared their decline after Mike Mayo, an analyst at Credit Agricole Securities (USA), raised his rating to outperform from underperform. Mayo’s price target is $16. The stock is 55 percent below where it traded when Gorman took over, and is trading at about half the firm’s liquidation value.

Morgan Stanley has already cut 3,272 jobs since the start of 2012 and expects that number to climb to 4,000 by year’s end, Chief Financial Officer Ruth Porat said in an interview. Reductions will be gradual and some may come from attrition, she said. About 350 jobs were eliminated with the sale of U.K. wealth manager Quilter Holdings Ltd. in April.

Revenue dropped to $6.95 billion from $9.21 billion a year earlier. Book value per share rose to $31.02 from $30.74 at the end of March.

Second-quarter revenue from fixed-income sales and trading, which is run by Ken deRegt, along with commodity trading co- heads Colin Bryce, and Simon Greenshields, all 56 years old, was $770 million, excluding the accounting gain. That missed estimates of $1.1 billion from Citigroup Inc.’s Keith Horowitz, and $1.39 billion from Barclays Plc’s Roger Freeman.

Shrinking Unit

Gorman vowed to shrink the fixed-income division in order to free up capital and improve returns. Risk-weighted assets in the unit have already been cut 15 percent in the past nine months, he said. The reduction will reach 25 percent by the end of 2013, Gorman said on a conference call with analysts, declining to provide the firm’s total risk-weighted assets, known as RWAs.

The accounting gain is known as a debt-valuation adjustment, or DVA. It stems from a decline in the price of the company’s bonds, under the theory it would be cheaper to buy back the debt. Morgan Stanley booked $2 billion of losses in the first quarter as cost of repurchasing the debt rose.

Fixed-income revenue was down 70 percent from $2.59 billion in the first quarter and 60 percent from $1.9 billion in the second quarter of 2011. Goldman Sachs (GS)’s fixed-income revenue, excluding DVA, climbed more than 40 percent from a year earlier to $2.19 billion. Citigroup’s fell 4 percent to $2.82 billion, while JPMorgan Chase & Co. posted a 17 percent decline to $3.49 billion.

Rating Cut

Porat said the results included a $225 million charge related to $2.9 billion of collateral it had to post after Moody’s cut the firm’s credit rating by two levels last month. The ratings review also hurt client activity with the firm, Porat said.

“As the speculation on the ratings outcome lingered, clients did seem to take a wait-and-see approach,” she said. “Having that ratings action addressed, now having clarity on it and having that uncertainty gone, we’re seeing real relief among clients. Clients have re-engaged, and it’s good to have it behind us.”

In equities trading, headed by Ted Pick, 43, Morgan Stanley’s revenue fell 36 percent from the year-earlier period to $1.14 billion, excluding DVA. That was a 38 percent decline from the first quarter’s $1.83 billion, and compared with $1.7 billion at Goldman Sachs, $1.04 billion at JPMorgan and $550 million at Citigroup. Brad Hintz, an analyst at Sanford C. Bernstein, had estimated revenue of $1.45 billion, while Barclays’s Freeman estimated $1.38 billion.

Goldman Sachs

Citigroup on July 16 beat analysts’ estimates on revenue from advising on mergers, corporate lending and underwriting stocks and bonds. Goldman Sachs said the next day it plans to cut $500 million in expenses after reporting the lowest first- half revenue and earnings in seven years. Both companies are based in New York.

The two companies cited a decline in trading and merger volume amid concern that Greece would leave the euro and the region’s debt crisis would spread to nations including Spain and Italy.

Morgan Stanley’s credit-default swaps have fallen since June 21, when Moody’s cut the firm’s credit rating two grades instead of the threatened three levels. Morgan Stanley avoided the biggest potential downgrade among U.S. firms because of support from Mitsubishi UFJ Financial Group Inc., its largest shareholder, Moody’s said.

Collateral Call

The firm had to post collateral of $2.9 billion as a result of the downgrade, the company said today. Counterparties have called another $800 million so far in July, and the pace of demands has been “measured,” Porat said.

Morgan Stanley generated $884 million in second-quarter revenue from investment banking, which is overseen by Paul J. Taubman, 51. That figure, down 40 percent from a year earlier, included $263 million from financial advisory, $283 million from equity underwriting and $338 million from debt underwriting.

Morgan Stanley was the second-ranked equity underwriter in the quarter, according to data compiled by Bloomberg. It was the lead underwriter on Facebook Inc.’s initial public offering, which set a record for technology companies by raising more than $16 billion. The stock has dropped 23 percent since the IPO, leading to shareholder lawsuits claiming the company and its underwriters overpriced Facebook at $38 a share.

Same Process

Morgan Stanley said it adhered to the same procedures it follows for all IPOs and complied with all applicable regulations.

Global wealth management, overseen by Greg Fleming, 49, posted pretax income of $393 million, up from $317 million a year earlier, as revenue fell 4 percent to $3.31 billion. The division’s pretax profit margin rose to 12 percent from 9 percent in the second quarter of 2011.

Gorman said the bank finished the technology integration of the Morgan Stanley Smith Barney brokerage this month. He has previously said his target is a 20 percent pretax margin. The figure was 11 percent in the first quarter, and Fleming has vowed to raise the margin to “mid-teens” by the middle of next year.

Morgan Stanley said in May it would exercise the option to buy a 14 percent stake in the venture from Citigroup, increasing its ownership to 65 percent. The two companies’ valuations of the unit’s value were more than 10 percent apart, requiring a third-party appraiser to complete the deal, Porat said in the interview.

Asset management reported a pretax gain of $43 million, down from $168 million in the previous year’s period.

Compensation and benefits decreased 21 percent from the year-earlier quarter to $3.63 billion, or 52 percent of the firm’s overall revenue. The ratio was higher than in the second quarter of 2011, when the bank set aside 50 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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