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Morgan Stanley Beats Estimates on Investment Banking

James Gorman
James Gorman, chairman and chief executive officer of Morgan Stanley. Photographer: Andrew Harrer/Bloomberg

Morgan Stanley, owner of the world’s largest brokerage, reported earnings that beat analysts’ estimates as profit from that business rose to a record and fees from investment banking reached a three-year high.

Second-quarter net income almost doubled to $1.94 billion, or 94 cents a share, from $980 million, or 41 cents, a year earlier, the New York-based company said today in a statement. Excluding a tax benefit and an accounting adjustment tied to the firm’s own debt, profit was 60 cents a share, topping the 56-cent average estimate of 24 analysts surveyed by Bloomberg.

Morgan Stanley, the No. 2 adviser on global announced mergers and acquisitions this year, said investment-banking revenue jumped 33 percent in the second quarter, the biggest increase among its peers. The brokerage’s profit margin increased to 21 percent, the highest since the firm bought Smith Barney from Citigroup Inc. in 2009.

“The improving profitability in wealth management was the standout for us in the quarter,” said Shannon Stemm, an analyst at Edward Jones & Co. “Investment banking was the other area of strength. Some of that was just a factor of the market environment; M&A has been robust lately, and Morgan is winning their fair share of that.”

Morgan Stanley fell 0.6 percent to $32.30 at 4:15 p.m. in New York, after rising as much as 2 percent earlier today. The shares climbed 3.6 percent this year through yesterday, the best performance among the largest Wall Street firms.

Tax Benefit

Results for the quarter included a tax benefit of $609 million or 31 cents per diluted share, related to the remeasurement of reserves and related interest, the firm said.

Revenue excluding accounting adjustments rose to $8.52 billion from $8.34 billion a year earlier. Book value per share climbed to $33.48 from $32.38 at the end of March.

Investment banking, led by Mark Eichorn and Franck Petitgas, generated $1.43 billion in second-quarter revenue. That figure includes $418 million from financial advisory, $489 million from equity underwriting and $525 million from debt underwriting.

Return on equity, a measure of how well management reinvests earnings, was 7.8 percent in the first half, excluding accounting adjustments and the tax benefit. That was still below 10 percent, the firm’s estimate of its cost of equity.

ROE Goal

Morgan Stanley, which earned a return on equity of about 5 percent in each of the past two years, has a plan to “in 2015 and beyond, sustainably drive ROE at 10 percent or higher,” Chief Executive Officer James Gorman, 56, said at an investor conference last month.

Gorman’s plan relies in part on increasing dividends and share buybacks. He said he hopes to return as much as 100 percent of earnings to shareholders in the next few years. The firm announced a $1 billion stock buyback plan for the 12 months ending next March and doubled its dividend to 10 cents a share. The bank said today it bought back $284 million in the second quarter.

Pretax profit from global wealth management, overseen by Greg Fleming, 51, jumped 17 percent to $767 million as revenue climbed to $3.72 billion.

Morgan Stanley boosted its targets for the wealth-management unit’s profit margin earlier this year, saying it can produce 25 percent by the fourth quarter of next year even without help from higher markets or interest rates. Gorman has said one lever for higher returns will be to boost lending to its 4 million brokerage customers.

Fixed Income

Second-quarter revenue from fixed-income trading, run by Michael Heaney and Robert Rooney with commodity trading co-heads Colin Bryce and Simon Greenshields, was $1.01 billion, excluding an accounting gain known as debt valuation adjustments, or DVA. That compared with estimates of $951 million from Brian Kleinhanzl, an analyst at Keefe, Bruyette & Woods Inc., and $980 million from Nomura Holdings Inc.’s Steven Chubak.

While fixed-income revenue dropped 12 percent from a year earlier, excluding DVA, it rose excluding a charge related to the firm’s own credit spreads known as a credit valuation adjustment, Chief Financial Officer Ruth Porat said in an interview.

Credit-trading revenue increased from a year earlier, while foreign exchange had a decline and commodities trading revenue dropped significantly from the first quarter, she said. Fixed-income trading revenue was $2.22 billion at Goldman Sachs Group Inc. and $3 billion at Citigroup.

JPMorgan, Citigroup

JPMorgan Chase & Co. and Citigroup posted earnings this week that topped estimates on smaller-than-expected drops in fixed-income trading revenue. Analysts had lowered profit projections for all the major banks after firms warned of slow bond markets in May, only to see a pickup in June.

Morgan Stanley has exited some units within its fixed-income and commodities division and has been shrinking capital dedicated to that segment. The bank had $192 billion of risk-weighted assets tied to the unit at the end of June, Porat said. That’s down from about $300 billion in the second quarter of 2012 and $199 billion at the end of March.

Gorman said on a conference call with analysts that the reduced capital led to a higher return on equity for the fixed-income trading unit.

The bank this month completed a sale of its stake in oil-transportation company TransMontaigne Inc. to NGL Energy Partners LP for $200 million. That sale will reduce risk-weighted assets by an additional $2 billion, Porat said on the call.

Rosneft Sanctions

Morgan Stanley agreed in December to sell its oil-merchanting business to Moscow-based OAO Rosneft. Porat said today that new U.S. sanctions against the Russian company won’t affect the transaction, which Morgan Stanley expects to be completed by the end of the year.

In equities trading, headed by Ted Pick, revenue fell 1 percent from a year earlier to $1.79 billion, excluding the accounting adjustment. That compared with $1.03 billion at Bank of America Corp. and $1.63 billion at Goldman Sachs. Kleinhanzl had estimated equities revenue of about $1.71 billion, while Chubak predicted $1.67 billion.

Morgan Stanley was the top bank in equity trading for the third time in the past four quarters, and had its highest revenue share among the five largest Wall Street firms since the financial crisis, according to data compiled by Bloomberg.

Asset management reported a pretax gain of $205 million, compared with $160 million in the previous year’s period.

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