Morgan Stanley Beats Estimates on Accounting Gain, Trading

Morgan Stanley Beats Estimates on Accounting Gain
Morgan Stanley posted the biggest year-over-year increase in equities trading excluding accounting gains among the largest U.S. banks. Photographer: Scott Eells/Bloomberg

Morgan Stanley, owner of the world’s largest brokerage, reported profit that beat analysts’ estimates on a $3.4 billion accounting gain and higher revenue from stock trading.

Net income was $2.2 billion, or $1.15 a share, compared with $131 million, or a loss of 7 cents a share after preferred dividends, a year earlier, the New York-based company said today in a statement. Earnings beat the 30-cent average estimate of 25 analysts surveyed by Bloomberg.

Morgan Stanley’s 20 percent gain in year-over-year equities-trading revenue was the biggest among the largest U.S. banks, excluding the accounting benefit. Fixed-income fell 17 percent. Chief Executive Officer James Gorman, 53, is trying to stem a 39 percent decline in the firm’s shares this year through yesterday that left the stock trading at a level last seen during the financial crisis in January 2009.

“We saw more activity on the cash equities side, particularly in electronic trading, and the derivatives business continued to do well,” Chief Financial Officer Ruth Porat said in an interview after earnings were released. “The more challenging part of the market was in the fixed-income market.”

Excluding the $3.4 billion accounting gain, known as debt valuation adjustments, or DVA, profit was 3 cents a share, compared with estimates of a 9-cent loss from Citigroup Inc. analyst Keith Horowitz and a 23-cent loss from Barclays Capital’s Roger Freeman.

Share Performance

Shares of the company rose 1 cent to $16.64 at 4:15 p.m. in New York, after surging 9.1 percent yesterday.

The DVA gain stems from declines in the value of the company’s debt, under the theory that a profit would be realized if the debt were repurchased at a discount. Citigroup and JPMorgan Chase & Co. each booked more than $1.5 billion of such gains as bank credit spreads widened in the quarter.

“It is a bizarre accounting anomaly,” Gorman said in an interview with Erik Schatzker on Bloomberg Television. “Next quarter, we may have $3.4 billion of negative adjustments.”

Revenue at Morgan Stanley climbed 46 percent to $9.89 billion from $6.78 billion a year earlier. Book value per share rose to $31.29 from $30.17 at the end of June. The firm’s return on equity from continuing operations, a measure of how well it reinvests earnings, was 14.5 percent.

Fixed Income

Trading revenue at five of the largest U.S. banks dropped by a combined 32 percent from the second quarter and was less than half that of the first quarter, excluding DVA. Morgan Stanley is “constantly reassessing” whether the current environment represents a cyclical or secular change, Gorman said on the conference call.

“Over the next several months, it will become clearer which of the businesses that use a lot of balance sheet and take on a lot of risk can be expected to generate the kind of return that shareholders need,” Gorman said in the Bloomberg Television interview.

Third-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, was $3.88 billion. Excluding DVA, fixed-income revenue was about $1.1 billion, down from $1.9 billion in the second quarter and $1.31 billion in the third quarter of 2010. The figure compared with $2.8 billion at JPMorgan, $2.27 billion at Citigroup and $1.43 billion at Goldman Sachs Group Inc.

Foreign Exchange

Interest-rates trading revenue increased from the second quarter, and the firm saw share gains in foreign-exchange trading, Porat said on a conference call with analysts. Credit trading suffered from “illiquidity” in the corporate credit and mortgage markets, she said.

Losses from hedges tied to monoline insurers reduced fixed-income trading revenue by $284 million, Porat said. The bank booked about $400 million of writedowns in corporate lending in its revenue line labeled “other sales and trading,” said Mark Lake, a company spokesman.

In equities trading, headed by Ted Pick, Morgan Stanley’s third-quarter revenue was $1.96 billion. Excluding DVA, revenue fell 26 percent from the second quarter to $1.34 billion. That compared with $2.18 billion at Goldman Sachs and $289 million at Citigroup.

Morgan Stanley generated $864 million in third-quarter revenue from investment banking, which is overseen by Paul J. Taubman. That figure, down 14 percent from a year earlier, included $413 million from financial advisory, $239 million from equity underwriting and $212 million from debt underwriting.

Expense Control

“Core trading and investment-banking revenue held up better than our muted estimates while expense control was good,” Ed Najarian, an analyst at International Strategy & Investment Group Inc., said today in a note to clients.

Global wealth management, overseen by Greg Fleming, posted pretax income of $362 million, up from $281 million in the third quarter of 2010. It also had $15.5 billion in net new assets. The division’s pretax profit margin rose to 11 percent from 10 percent in the first half. Gorman has said the unit should eventually post a pretax profit margin of more than 20 percent.

Asset management reported a pretax loss of $117 million, compared with profit of $279 million in the previous year’s period.

Compensation and benefits were unchanged from the year-earlier quarter at $3.68 billion, or 37 percent of the firm’s overall revenue. The ratio was lower than in the third quarter of 2010, when the bank set aside 54 percent of revenue.

Morgan Stanley increased its forecast for annual savings from an initiative to trim expenses to $1.4 billion, from $1 billion when the three-year project was announced in May.

Share Volatility

The firm’s shares fell 41 percent in the third quarter. The stock dropped further in the first week of October to $11.58, the lowest since December 2008.

The volatility prompted Mitsubishi UFJ Financial Group Inc., Morgan Stanley’s largest common shareholder, to release a statement on Oct. 3 saying it’s “firmly committed” to its strategic alliance with Morgan Stanley. Gorman sent a memo to employees the same day, encouraging them to remain focused on their jobs and clients instead of responding to “the rumor of the day.”

“There has been an enormous amount of confusion and misinformation about Morgan Stanley and others in our peer group,” he wrote in the memo, which was obtained by Bloomberg News. “In fragile markets, where fear triumphs over common sense, these things are bound to happen.”

The bank repurchased about $2 billion of its own bonds as prices fell, Porat said. The gain on the buybacks was less than $100 million, she said.

Morgan Stanley updated figures for risks linked to Europe in a presentation on its website today, saying the five countries at the center of Europe’s debt crisis totaled $2.11 billion in exposure including hedges against losses. The risks linked to France were negative $286 million.

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