June 18, 2008 / 12:10 PM / 11 years ago

Morgan Stanley earnings tumble even after gains

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.

The Morgan Stanley headquarters is seen in New York January 30, 2008. REUTERS/Shannon Stapleton

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.

Kelleher said the company does not plan further reductions in that ratio and that the bank is preparing itself to profit from opportunities stemming from market turbulence.

WEAKNESS ACROSS THE BOARD

In the past quarter, revenue dropped in almost every business. Investment banking fees fell by half, and fixed income trading net revenue sank by 85 percent, reflecting the mortgage losses as well as setbacks in other markets.

Equity trading revenue fell 11 percent to $2.1 billion, hurt by lower results from trades made with its own funds.

Kelleher told Reuters the firm’s commodity results declined on its contrarian bets that energy prices would stop rising, when they instead soared to record highs.

Its asset management division posted a $277 million loss, driven by a $150 million write-down on its investment in Crescent Real Estate. Like most Wall Street losses, Morgan saw the value of a real estate investment fall before it could be removed from its books.

Despite the weak results, there were some positive signs, such as an increase in Morgan’s backlog of pending deals. The firm’s asset management arm saw more new client cash, and a 4 percent rise in wealth management revenue beat expectations.

Most encouraging, though, were signs that debt market trading activity has revived since March, when panic drove Bear Stearns into the ground and investors fled to the sidelines.

“After a difficult start to the quarter, customer flow activity returned to more normal levels in May and these flows have continued into June,” Kelleher told analysts.

Markets remained nervous, he said, mindful of inflation fears, energy prices, unemployment and the U.S. housing slump.

PRESSURE ON MACK

The latest results added to pressure on Chief Executive John Mack, who took over an underperforming Morgan Stanley in 2005 and pushed the company to take on more trading risk, expand leveraged lending and build out an integrated mortgage business at the market’s peak.

Last year, Morgan Stanley sold a $5 billion equity stake to a Chinese government-controlled fund. It has also cut thousands of jobs and pared its balance sheet. On the conference call, Kelleher said the firm may slash payrolls again if markets deteriorate.

Morgan’s report followed that of rival Lehman Brothers Holdings Inc LEH.N, which posted a $2.8 billion loss Monday after weeks of speculation its financial strength was in trouble.

Goldman Sachs said Tuesday its profit fell by 11 percent, beating expectations amid relatively light losses and surprisingly strong debt-trading results.

“Not only was Morgan Stanley’s result far below that of Goldman; even Lehman did better” in terms of attracting client business, Fox-Pitt Kelton analyst David Trone said.

Its stock trimmed early losses, ending up 26 cents to $40.85 after falling as low as $37.42 on the New York Stock Exchange. It was among the most active issues on the NYSE.

Shares of Morgan Stanley have fallen 28 percent this year, lagging the Amex Securities Broker-Dealer Index .XBD and the broader S&P 500 Index.

Morgan Stanley’s shares are valued at about 1.3 times the firm’s assets minus liabilities. That’s a discount to Goldman’s 1.8 times book but above Lehman’s 0.7 times.

Additional reporting by Dan Wilchins and Phil Wahba; Editing by Steve Orlofsky/Jeffrey Benkoe

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