* Adjusted profit 28 cents/share vs Street view 24 cents
* Clients coming back to bank's bond trading desk
* Shares down 3.7 percent
By Lauren Tara LaCapra
Oct 18 Morgan Stanley reported
better-than-expected adjusted quarterly earnings on Thursday as
it boosted revenue from trading bonds, long a sore spot for the
Morgan Stanley's bond trading business suffered over the
summer, hurt by an expected ratings downgrade by Moody's. But
the cut was smaller than many observers had feared, and Morgan
Stanley's trading business revived in the third quarter, Chief
Financial Officer Ruth Porat said.
"Clients re-engaged and continued to re-engage throughout
the quarter," Porat told Reuters in an interview.
Morgan Stanley laid off hundreds of its fixed-income trading
staff after the financial crisis, leaving it poorly positioned
to benefit from the frenzied bond trading that occurred in 2009
For more than three years, executives have been talking
about boosting market share in fixed-income trading. Last year
the bank set a target of raising its share of Wall Street's bond
trading revenue pie by 2 percentage points. At the time,
analysts said its share was 6 percent.
Progress has been halting, but on Thursday Morgan Stanley
said bond-trading revenue in the third quarter climbed 33
percent from a year earlier to $1.5 billion, excluding the
accounting impact of changes in value of the bank's debt.
Overall adjusted trading revenue rose 21 percent, to $3.6
billion, with gains in interest rate and credit trading. Most of
the increase came from increased client activity, rather than
rising asset values, Porat said.
Despite better-than-expected results in both its bond
trading and wealth-management operations, Morgan Stanley shares
fell 3.8 percent on Thursday, with analysts citing concerns
about the sustainability of its performance, and investor
concerns about high costs weighing on returns.
Roger Freeman, an analyst who covers Morgan Stanley for
Barclays Capital, said the company's bond-trading performance
far surpassed his expectations and rose more than Wall Street
rivals like Goldman Sachs Group Inc, which had earlier
reported better-than-expected results.
"These results likely put Morgan Stanley at the top of the
pack," Freeman said, but he also noted skepticism about the bank
sustaining its No. 1 position, given its uneven performance over
the past several years.
Since setting out its market-share gains target, Morgan
Stanley management has also made strategic decisions about how
to adjust its bond-trading business to lessen capital needs.
The bank is more focused on areas of the market that can be
automated and where securities can easily be sold to clients
instead of being kept in inventory, such as U.S. government
debt. The firm plans to reduce risk-weighted assets by more than
$100 billion from their Sept. 30, 2011, level, in part by
exiting riskier, more complex trading businesses.
There was a slight rise in risk-weighted assets last
quarter, though Porat said Morgan Stanley is still "very much on
track" to meet its target.
The bank's capital levels rose during the quarter, partly
because of a change in the way it calculates value-at-risk
(VaR), or the amount of money the firm can lose in a single
Instead of using the last four years of volatility in its
measurement, as it previously did, Morgan Stanley now looks back
just one year. That reduces volatility measures, and therefore
the amount of capital it must hold against assets.
Under the new formula, Morgan Stanley's average daily
trading VaR last quarter was $63 million, rather than $82
million under the previous model. The change helped capital
levels by a "modest" amount, Porat said. Under upcoming Basel
III capital standards, Morgan Stanley's Tier 1 common capital
ratio would be above 9 percent, she said, up from just under 8.5
percent in the second quarter.
Overall, Morgan Stanley lost money in the third quarter due
to a $2.3 billion accounting charge to reflect an increase in
the value of the bank's debt.
Including that charge, Morgan Stanley lost $1 billion, or 55
cents per share, in the quarter.
U.S. accounting rulemakers are changing the rule that
requires earnings to reflect changes in a bank's debt values.
Analysts and investors tend to ignore income and losses from
debt value adjustments because the adjustments swing wildly but
have little impact on a bank's daily business.
On that basis, Morgan Stanley's income from continuing
operations totaled $561 million, or 28 cents per share, in the
third quarter, compared with $64 million, or 2 cents per share,
a year earlier. Analysts had been expecting comparable earnings
of 24 cents per share, according to Thomson Reuters I/B/E/S.
In addition to the trading business, Morgan Stanley's global
wealth management business also showed improvement, when
excluding one-time integration costs and its purchase of an
additional stake in a retail brokerage joint venture with
The adjusted pretax profit margin for the business rose to
13 percent from 11 percent. Management has targeted a pretax
margin in the "mid-teens" for wealth management by next year.
However, overall expenses rose 11 percent on higher
integration costs, as well as litigation costs. And while
compensation declined as a percentage of revenue, those expenses
rose on an absolute basis.
On a conference call with analysts, Porat and Chief
Executive James Gorman said they are examining ways to reduce
compensation costs further.