Morgan Stanley Beats Estimates on Fixed-Income Gains

Morgan Stanley Beats Estimates on Rise in Fixed-Income Revenue
Morgan Stanley signage is displayed outside of the company's headquarters in New York, U.S., on Thursday, July 19, 2012. Photographer: Victor J. Blue/Bloomberg

Morgan Stanley, the sixth-largest U.S. bank, reported third-quarter results that beat analysts’ estimates as revenue from fixed-income trading almost doubled from the second quarter.

Morgan Stanley posted a loss of $1.01 billion, or 55 cents a share, compared with a profit of $2.2 billion, or $1.15, a year earlier, the New York-based firm said today in a statement. Excluding accounting adjustments and a one-time restructuring cost, profit was about 35 cents a share, compared with the 25-cent average estimate of 22 analysts surveyed by Bloomberg.

Chief Executive Officer James Gorman, 54, is trying to improve returns at the brokerage unit and shrink the fixed-income trading division to reduce capital demands. The bank had the lowest first-half return on equity among the 10 largest U.S. lenders and trades at two-thirds of its liquidation value, compared with 96 percent at Goldman Sachs Group Inc.

“The rebound in fixed-income and commodities sales and trading indicates that clients have re-engaged after the uncertainty of the rating review in the previous quarter,” Gorman said in the statement, referring to Moody’s Investors Service’s two-level downgrade of Morgan Stanley’s credit rating in June.

Share Performance

Morgan Stanley fell 3.8 percent to $17.79 at 4:15 p.m. in New York trading, after gaining 3.5 percent yesterday. The shares declined 44 percent in 2011, the biggest drop since 2008. They are 40 percent below where they traded when Gorman took over at the beginning of 2010.

While the quarter showed progress, the firm posted a return-on-equity of about 6 percent, trailing rivals including Goldman Sachs and below Morgan Stanley’s cost of equity, Glenn Schorr, a Nomura Holdings Inc. analyst, wrote in a note to investors. Schorr said he expected Morgan Stanley to continue trading below tangible book value.

Gorman said on a conference call today that “it’s not a terribly heroic assumption” that the firm will increase ROE to its cost of equity, which Fiona Swaffield, a Royal Bank of Canada analyst, estimated last year at 11.5 percent. Gorman cited the firm’s ROE in the first quarter of the year, which was 9 percent excluding accounting charges. That was the highest since the start of 2011.

Book Value

Revenue excluding accounting charges climbed to $7.55 billion from $6.40 billion a year earlier. Book value per share fell to $30.53 from $31.02 at the end of June, while tangible book value, which excludes some assets such as goodwill, fell to $26.65.

“We see third-quarter trends as relatively good in a tough environment and view revenue performance as broadly better combined with some nice comp discipline,” Keith Horowitz, a Citigroup Inc. analyst, wrote in a note to clients.

The accounting charge is known as a debt-valuation adjustment, or DVA. It stems from increases in the value of the company’s debt, under the theory it would be more expensive to buy back the debt and extinguish the interest payments. Morgan Stanley booked a $3.4 billion gain in the year-earlier quarter as yields on its debt rose compared with Treasuries.

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 $1.46 billion, excluding DVA. That topped estimates of $1.2 billion from Atlantic Equities LLC’s Richard Staite, and $1.1 billion from Barclays Plc’s Roger Freeman.

Fixed Income

Fixed-income revenue climbed 89 percent from $770 million in the second quarter and 33 percent from $1.1 billion in the third quarter of 2011. Goldman Sachs’s fixed-income revenue, excluding DVA, increased 72 percent from a year earlier to $2.45 billion. Citigroup’s jumped 63 percent to $3.7 billion, while New York-based JPMorgan Chase & Co. posted a 33 percent increase to $3.73 billion.

Gorman has pledged to shrink the fixed-income trading division, or FICC, which requires a majority of the firm’s regulatory capital and has trailed revenue of rivals since the financial crisis. Morgan Stanley plans to cut risk-weighted assets within fixed-income and commodities, overseen by Colm Kelleher, from $320 billion on June 30 to $255 billion by the end of 2014, Chief Financial Officer Ruth Porat, 54, said last month.

‘Relatively Small’

“While we are impressed with the FICC revenue number, the scale of revenues at $1.5 billion is still relatively small compared to the larger players like Citi, which made $3.7 billion, and Goldman Sachs,” Kian Abouhossein, an analyst at JPMorgan, wrote in a note to clients. “Hence we appreciate management announcing FICC RWA reductions, which is the right strategy in our view.”

Part of the reduction could come from selling a stake in its commodities unit. Qatar is considering investing in the unit, Prime Minister Sheikh Hamad bin Jassim Al Thani said this week. The commodities business, which includes trading in futures contracts and buying and selling physical commodities, may be affected by the Volcker rule, which limits banks’ ability to trade for their own account.

The commodities unit is a “strong, attractive business,” Porat said in an interview today. She declined to comment on the potential for a deal with Qatar.

Different Structures

“With the Dodd-Frank legislation, there are potential limits to some of the activities that we can pursue in that business, so it’s incumbent upon us to explore all forms of different structures, appropriate structures, that can take us forward where we can get the benefits of the business but also meet the regulatory constraints that we operate under,” Gorman said on the call.

In equities trading, headed by Ted Pick, Morgan Stanley’s revenue fell 8 percent from the year-earlier period to $1.23 billion, excluding DVA. That was a 7 percent increase from the second quarter’s $1.14 billion, and compared with $2.1 billion at Goldman Sachs and $1.04 billion at JPMorgan. Brad Hintz, an analyst at Sanford C. Bernstein, had estimated revenue of $1.1 billion, while Credit Suisse Group AG’s Howard Chen estimated $1.2 billion.

Morgan Stanley generated $969 million in third-quarter revenue from investment banking, which is overseen by Paul J. Taubman. That figure, up 12 percent from a year earlier, included $339 million from financial advisory, $199 million from equity underwriting and $431 million from debt underwriting.

Wealth Management

Global wealth management posted pretax income of $239 million, down from $356 million a year earlier, as revenue climbed 3 percent to $3.34 billion. The division’s pretax profit margin fell to 7 percent from 11 percent in the third quarter of 2011.

Greg Fleming, who runs the business, vowed to raise the unit’s pretax margin to the “mid-teens” by the middle of next year. Excluding one-time charges, the firm said the margin rose to 13 percent from 12 percent in the second quarter.

Morgan Stanley now owns 65 percent of its brokerage joint venture with Citigroup after paying $1.89 billion for an additional 14 percent stake in September following a two-month fight over its value. The two banks agreed on a valuation for the purchase of the remaining 35 percent stake, which Morgan Stanley must buy all of by June 2015. The firm will probably ask the Federal Reserve for approval to purchase the rest next year, according to a person briefed on the bank’s thinking.

Asset management reported a pretax gain of $198 million, compared with a loss of $118 million in the previous year’s period.

Compensation and benefits increased 8 percent from the year-earlier quarter to $3.93 billion, or 52 percent of the firm’s total revenue, excluding DVA. The ratio was lower than in the year-earlier quarter, when the bank set aside 57 percent of revenue on that basis.


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