Morgan Stanley earnings tumble even after gains

By Joseph A. Giannone

NEW YORK (Reuters) - Morgan Stanley (MS.N) said on Wednesday quarterly earnings dropped 57 percent on weak trading, investment losses and a slowdown in investment banking, even after it realized $1.43 billion in one-time gains.

Morgan Stanley shares fell as much as 8 percent as investors questioned the quality of its earnings, which paled next to those of rival Goldman Sachs Group Inc (GS.N), and after Chief Financial Officer Colm Kelleher's cautious views.

"This has been an unusually stressed quarter," Kelleher told Reuters. "We were very troubled by what was happening ... We decided we would stay very conservative, strengthening our liquidity and capital positions."

Morgan Stanley, the second-largest U.S. investment bank, reported income from continuing operations sank to $1.03 billion, or 95 cents a share, for its fiscal second quarter ended May 31, from $2.36 billion, or $2.45, a year earlier.

Net revenue dropped 38 percent to $6.51 billion, dragged lower by a failed contrarian bet on energy, a big write-down caused by a London trader who violated company policy and write-downs on assets hurt by the ongoing credit crisis.

Meanwhile, most of the profits came from two one-time pretax gains: $698 million from the sale of its Spanish wealth management business, and $732 million from the sale of part of its stake in MSCI Inc (MXB.N). The gains contributed 88 cents a share to earnings.

Some analysts said the investment bank's true earnings were just a few pennies per share, far short of average analyst expectations of 92 cents.

PULLING RABBITS

"If you have to go all the way to Spain to make numbers, it's not good. How many more rabbits do they have in their hat?" said Matt McCormick, a stock analyst at Bahl & Gaynor Investment Counsel in Cincinnati. "What's going to be the driver of earnings growth going forward?"

Gains from asset sales helped offset $245 million in severance related to job cuts, $436 million in losses from proprietary mortgage trades and $519 million in net losses on leveraged loans.

Morgan Stanley also said an unnamed London trader violated company policies by misrepresenting his positions, resulting in a $120 million write-down. The trader has been suspended, pending an internal investigation. Kelleher told a conference call with analysts the problem was isolated.

The credit crunch has battered banks and brokers, which have been forced to write down more than $400 billion in assets, slash jobs and raise expensive new capital.

Morgan Stanley suffered $9.4 billion in fourth-quarter mortgage losses, then reported a 50 percent drop in first-quarter earnings.

The latest weak results from Morgan Stanley along with regional bank Fifth Third Bancorp's (FITB.O) dividend cut and moves to raise $2 billion in capital, sent credit protection costs for banks and brokers higher.

Investors and regulators are pushing investment banks to cut their assets relative to capital, which reduces risk but also drags on potential returns down the road. Morgan's ratio of assets to equity fell to 25.1 from 27.4 in the first quarter.