Morgan Stanley Tops Estimates on Record Brokerage Earnings

Jan 17, 2014 9:51 am ET

(Updates with analyst’s comment in ninth paragraph.)

Jan. 17 (Bloomberg) -- Morgan Stanley, owner of the world’s largest brokerage, reported profit that beat analysts’ estimates as equity-trading revenue increased and earnings from wealth management climbed to a record.

Fourth-quarter net income fell to $181 million, or 7 cents a share, from $594 million, or 29 cents, a year earlier, the New York-based company said today in a statement. Profit was 50 cents a share excluding an accounting charge tied to the firm’s own debt, a tax benefit and legal expenses, beating the 44-cent average estimate of 26 analysts surveyed by Bloomberg.

Morgan Stanley’s stock climbed 64 percent in 2013, the most among the 10 largest global investment banks, as Chief Executive Officer James Gorman cut costs and improved margins at the brokerage unit. A 30 percent jump in the Standard & Poor’s 500 Index helped boost equity trading and wealth-management revenue.

“Morgan Stanley is a little more levered toward the equity-centric businesses than competitors,” Devin Ryan, a bank analyst at JMP Group Inc. in New York, said before the results were announced. “There’s positive momentum in those businesses going into 2014.”

The company’s $1.2 billion addition to legal reserves in the fourth quarter pertained to “mortgage-related matters, specifically litigation and investigations related to residential mortgage-backed securities and the credit crisis,” according to the statement.

Legal Issues

“We are continuing to address many of the legal issues from the financial crisis,” Gorman, 55, said in the statement. “We look forward to further progress on our strategic goals as we move into 2014 with strength and momentum.”

Morgan Stanley rose 3 percent to $32.96 in New York trading at 9:51 a.m. The shares have more than doubled since June 2012, and through yesterday were 8.1 percent above the price when Gorman took over at the end of 2009.

Revenue excluding accounting adjustments rose to $8.2 billion from $7.47 billion a year earlier. Book value per share climbed to $32.29 from $32.13 at the end of September.

The company surpassed revenue expectations with “better- than-expected strength in investment banking, global wealth management, and asset management,” Keith Horowitz, a Citigroup Inc. analyst, wrote in a note to investors.

Profit Goal

The firm’s return on equity excluding the accounting charge was 5.1 percent for the year, unchanged from 2012. While Morgan Stanley achieved its goals on cost cutting and reducing capital used by the trading business, the firm hasn’t reached its target of doubling ROE, a gauge of profitability.

Gorman said in May that the bank can post a 10 percent ROE by this year if regulators allow it to return a “reasonable” amount of capital to shareholders. The company announced a $500 million stock buyback in July. It repurchased $228 million in the fourth quarter, bringing the yearly total to $350 million.

The accounting charge is known as a debt-valuation adjustment, or DVA. It stems from increases in the value of the company’s debt, on the theory it would be more expensive to buy it back. The firm had a $368 million charge from DVA, versus a $511 million charge in the fourth quarter of 2012.

Pretax profit from global wealth management, overseen by Greg Fleming, 50, jumped 26 percent to $709 million as revenue climbed to a record $3.73 billion. The division’s pretax profit margin rose to 19 percent from 17 percent in the fourth quarter of 2012.

Margin Target

Morgan Stanley today set a margin target of 22 percent to 25 percent for the fourth quarter of 2015, assuming no change in interest rates or market levels. That was higher than the previous target of 20 percent to 22 percent Gorman laid out in June.

The brokerage also provides the firm with a growing deposit base that it’s seeking to use for lending in products such as mortgages and corporate lending. Morgan Stanley is targeting a 70 percent loan-to-deposit ratio next year, up from 55 percent in 2012, and Chief Financial Officer Ruth Porat said growth in the bank unit will be the biggest driver of ROE improvement.

The increase in asset prices globally in 2013 has helped boost performance at the brokerage, which generates more than a third of revenue from fee-based accounts that often earn a percentage of assets. Rising stock indexes have also benefited Morgan Stanley, which is the only Wall Street firm to generate more revenue from equity trading than fixed-income trading.

Equities Trading

In equities trading, headed by Ted Pick, Morgan Stanley’s revenue rose 7 percent from a year earlier to $1.5 billion, excluding DVA. That compared with $904 million at Bank of America Corp. and $1.73 billion at Goldman Sachs Group Inc. UBS AG’s Brennan Hawken had estimated equities revenue of about $1.58 billion, while Wells Fargo & Co.’s Matt Burnell predicted $1.43 billion.

Morgan Stanley topped all global investment banks in equity-trading revenue in the third quarter. The firm is now seeing an “acute” battle for equity traders, Colm Kelleher, head of the investment bank and trading division, said last month.

Fourth-quarter revenue from fixed-income sales and trading, run by Michael Heaney and Robert Rooney with commodity trading co-heads Colin Bryce and Simon Greenshields, fell 14 percent to $694 million, excluding DVA. That compared with estimates of $919 million from Wells Fargo’s Burnell and $800 million from UBS’s Hawken.

Interest-Rates Trading

Porat said the firm suffered from weak interest-rates trading revenue. Fixed-income revenue was $1.89 billion at Goldman Sachs and $2.33 billion at Citigroup.

Morgan Stanley’s head of interest-rates trading, Glenn Hadden, left earlier this month after two years with the firm. He said he had different views over how the business should be run than Heaney and Rooney, who took over leadership of the fixed-income division last year. Mitch Nadel and Jakob Horder were named to replace Hadden.

Morgan Stanley had its lowest share of fixed-income revenue among U.S. peers in at least four years. While the firm’s credit, securitized products and currency units reached their 10 percent return-on-equity goals, low returns in the commodity and interest-rates groups dragged down ROE. Morgan Stanley reiterated its goal of reaching 10 percent ROE firmwide.

“Given the continued weak performance of FICC, we remain skeptical that Morgan Stanley will achieve even this relatively low financial target,” Richard Staite, an analyst at Atlantic Equities LLP in London, said in a note to clients.

Fixed Income

Morgan Stanley exited some units within its fixed-income and commodities division and shrank capital dedicated to that segment. It had $210 billion of risk-weighted assets tied to the division at the end of December. The bank moved up its target for driving that number below $180 billion by one year, to 2015.

The Federal Reserve is weighing further restrictions on banks’ trading and warehousing of physical commodities as Congress scrutinizes potential conflicts of interest and manipulation in those markets. The central bank said recent accidents and natural disasters have increased concerns about the businesses.

Morgan Stanley agreed last month to sell a unit that stores, trades and transports oil products to a subsidiary of Russia’s OAO Rosneft. Porat said that unit broke even last year on a pretax basis. The firm has also said it’s exploring strategic options for its stake in TransMontaigne Inc., the Denver-based petroleum and chemical transportation and storage company.

Investment Banking

Investment banking, led by Mark Eichorn and Franck Petitgas, generated $1.36 billion in fourth-quarter revenue. That figure, up 11 percent from a year earlier, included $451 million from financial advisory, $416 million from equity underwriting and $495 million from debt underwriting.

Morgan Stanley was the second-ranked adviser on global announced mergers and acquisitions in 2013, according to data compiled by Bloomberg. It was the No. 3 underwriter of global equity, equity-linked and rights offerings, the data show.

Asset management reported a pretax gain of $337 million, compared with $221 million in the previous year’s period.

--Editors: Steve Dickson, Peter Eichenbaum