Morgan Stanley profit beats Street as equity trading surges

By Lauren Tara LaCapra

REUTERS - Morgan Stanley posted a higher-than-expected quarterly profit on Friday as stock trading revenue jumped 31 percent, surprisingly strong performance in a quarter when rivals posted smaller gains or even declines in that business.

Its rise in stock trading revenue helped offset the decline in fixed-income, currency and commodity trading, where revenue fell 44 percent. Morgan Stanley has had difficulty with fixed-income trading for years, but in the third quarter weak market conditions also shook most of the bank's competitors.

Morgan Stanley reshaped itself after nearly failing during the financial crisis, focusing more on businesses that offer relatively stable earnings, like wealth management, and dialing down risk-taking in fixed income, where it suffered big losses.

That strategy has been at times painful for the bank, as it missed out on big profit that rivals earned from bond trading, for example. But in the third quarter, its decisions resulted in unexpectedly high profit.

"If you had questions about the business plan going forward, they were answered this quarter," said Patrick Morris, managing director of Hagin Investment Management. Morris sold the firm's Morgan Stanley shares earlier this year, a move he now regrets.

In recent years Morgan Stanley has invested heavily in equity trading, hiring specialty sales staff to help institutional clients pick stocks and formulate complex trades.

After those investments, the bank's equity trading revenue rose globally in the third quarter in stocks, derivatives, and trading and financing positions for hedge funds, a business known as "prime brokerage," a spokesman said.

Morgan Stanley grew faster than many rivals in equities trading, and reported more revenue from the business than any other big Wall Street bank, both for the quarter and year-to-date. Morgan Stanley's outperformance was not the result of any one-time gains, Chief Financial Officer Ruth Porat said.

"It was another strong quarter across products and geographies and I've said that a number of quarters in a row," she told analysts on a conference call. She added that results were "notable" because the third quarter is typically slow, and industry volumes were down.

Although equity trading posted surprisingly large gains last quarter, wealth management has been the real centerpiece of Chief Executive James Gorman's strategy to stabilize earnings. Morgan Stanley completed its purchase of the Smith Barney brokerage from Citigroup Inc in the second quarter, effectively doubling the size of the business since Gorman joined the bank in 2006.

The combined franchise - now called Morgan Stanley Wealth Management - showed progress in the third quarter, with income more than doubling and the profit margin approaching Gorman's minimum goal of 20 percent.

Overall, Morgan Stanley posted third-quarter net income of $888 million, compared with a loss of $1.01 billion in last year's third quarter. On a per-share basis after preferred stock dividends, the bank earned 44 cents from continuing operations, compared with a loss of 55 cents in the same quarter last year. The year-earlier figures included a charge of $2.3 billion to reflect a rise in the value of Morgan Stanley's debt.

Excluding one-time items, Morgan Stanley earned 50 cents per share in the latest quarter, beating analysts' average estimate by 10 cents, according to Thomson Reuters I/B/E/S.

Overall revenue rose to $7.93 billion from $5.28 billion, driven by equities trading and the wealth management business.

Morgan Stanley shares closed 2.6 percent higher at $29.69 on the New York Stock Exchange on Friday.

FOCUS ON RETURNS

Some investors cautioned that Morgan Stanley still has work to do. The bank's return on equity from continuing operations, a measure of how well it wrings profit from shareholders' capital, was just 5.6 percent in the quarter, far below the 10 percent that many investors view as an acceptable minimum.

Gorman and Porat said the bank is working aggressively to boost returns by getting rid of fixed-income assets that tie up a lot of capital without producing much profit.

Trading activity in the bond market slowed markedly during the third quarter as investors braced for the Federal Reserve to start winding down its bond-buying stimulus program. When the Fed decided instead to hold off on tapering, investors decided they could hold on to their bonds a little longer instead of trading them.

While activity was slow across Wall Street, Morgan Stanley and Goldman performed worse than larger universal banking peers.

Morgan Stanley's adjusted revenue from fixed income, currency and commodities trading fell 44 percent to $835 million. Goldman posted a 47 percent drop in bond-trading revenue, excluding an accounting charge. Bank of America Corp and Citigroup reported declines of 20 percent and 26 percent, respectively.

Morgan Stanley is also trying to boost returns by buying back stock for the first time since 2008, and by continuing to trim expenses. Even though the bank has already reached a target set out last year to reduce expenses to 79 percent of revenue by the end of 2014, a team of 40 to 50 executives is focused on finding more cost-cutting opportunities globally.

"There is a culture of expense management across the firm that we haven't seen for a long time," Gorman said.

(Additional reporting by Tanya Agrawal; editing by John Wallace, Leslie Adler and Matthew Lewis)

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