Morgan Stanley's (MS.N) focus on cost cutting, combined with strong performance in equity trading, helped the Wall Street bank post better-than-expected results, although a pricey settlement pushed it into the red for the fourth quarter.
The bank reduced noninterest costs by 6 percent in the quarter, which was more than analysts had estimated, as it cut back on everything from bonuses to BlackBerry bills to capital-hungry trading operations.
But it still struggled to cut its single largest expense -- compensation.
Morgan Stanley set aside $16.4 billion, or 51 percent of net revenue, for compensation last year, a higher portion than its Wall Street peers.
The bank had limited ability to reduce pay because of severance costs related to layoffs, deferred obligations that came due in 2011 and higher productivity of financial advisers, which made them eligible for bigger paychecks.
Morgan Stanley Smith Barney brokers earned more pay last year than its traders and investment bankers combined -- $2.1 billion or 62 percent of wealth management net revenue, versus $1.55 billion or 42 percent of net trading and investment banking revenue. The revenue numbers exclude a one-time charge for a legal settlement.
In contrast, Goldman Sachs Group Inc (GS.N) had a compensation-to-revenue ratio of 42 percent and JPMorgan Chase & Co's (JPM.N) investment bank had a 34 percent ratio. Neither has significant brokerage operations.
"We're hitting costs very vigorously wherever we can," Chief Financial Officer Ruth Porat said in an interview.
Porat said the bank expects compensation to be a less challenging area in 2012, since there will be less deferred pay coming due. She reiterated an annualized expense savings target of $500 million by the end of 2012 for the wealth management business, a figure she expects to rise to $1.4 billion a year over the long term.
Morgan Stanley has the option to buy another 14 percent stake in the business from Citigroup Inc (C.N) in May at fair market value, and in a conference call with analysts CEO James Gorman said he favors using capital to do so, rather than spending money on share buybacks.
Morgan Stanley's shares rose 5.4 percent to close at $18.28 on the New York Stock Exchange on Thursday.
WORK IN PROGRESS
The focus on cutting costs comes as tighter regulation hit profitability of banks and market volatility amid the European debt crisis leads clients to trade less and delay deals, hurting revenue of Wall Street firms.
Morgan Stanley's overall revenue dropped 26 percent in the fourth quarter, to $5.7 billion, compared with a year earlier. It was the weakest revenue figure for the bank since the second quarter of 2009.
Other banks with large investment banking operations, such as Goldman Sachs, JPMorgan Chase & Co (JPM.N) and Bank of America Corp (BAC.N), have also posted lackluster revenue for these businesses.
Morgan Stanley lost $275 million, or 15 cents per share, in the fourth quarter, compared with earnings of $600 million, or 41 cents per share, a year earlier.
The loss was due to a charge of $1.7 billion, or 59 cents per share, related to a bond insurance settlement with MBIA Inc (MBI.N), which had been previously announced.
Morgan Stanley's loss from continuing operations of 14 cents a share was much better than the loss of 57 cents a share that Wall Street analysts had expected on average, according to Thomson Reuters I/B/E/S.
One bright spot was equity trading, where Morgan Stanley's revenue rose from the year-ago period and declined much less than peers from the third quarter, after adjusting for special accounting items. Other big Wall Street banks reported a quarterly decline of 20 percent in equity sales and trading revenue, on average, compared with Morgan Stanley's 5 percent drop, Nomura analyst Glenn Schorr estimated.
And although overall revenue was weak and pay was high, analysts were impressed by the progress Morgan Stanley has made in turning around its trading operation and reducing other expenses.
"On the whole, management is making progress cleaning up legacy issues and growing tangible book," said Schorr.
But he cautioned that Morgan Stanley's weak return-on-equity figure shows that the company "is still a work in progress."
In 2011, Morgan Stanley's ROE was 3.9 percent, compared with levels as high as 40 percent before the crisis. ROE is a key measure of profitability for shareholders.
One way to boost that figure is through more cost-cutting, but Morgan Stanley has been wary of reducing expenses to the point where it starts cutting into bone.
It was the last among major banks to dive into the Wall Street layoffs bloodbath last year, announcing plans only in mid-December to cut 1,600 employees from its payroll across all levels of banking and trading operations.
The bank had already cut hundreds of underperforming financial advisers from its wealth management business earlier in the year. The business ended 2011 with 887 fewer financial advisers than at the start.
On a net basis, including strategic hires, Morgan Stanley's workforce declined by 643 workers, or 1 percent, last year. The cuts were on par with the decline in workers at JPMorgan's investment bank, but less than Goldman's 7 percent decline.
Morgan Stanley made targeted cuts in businesses that will require more capital under new Basel III regulations, such as subprime debt securitization, Porat said. But it also invested in areas including equity derivatives, rates trading and foreign exchange trading to gain market share, she said.
"You've seen us continue to invest in the areas we think are important for growth, while at the same time being very meticulous about cost management," said Porat, who acknowledged that the fourth quarter was "a painful environment" for Wall Street.
(Reporting By Lauren Tara LaCapra in New York; Editing by Paritosh Bansal, Alwyn Scott, John Wallace, Tim Dobbyn and Matthew Lewis)