Morgan Stanley’s (MS) third-quarter earnings from continuing operations came in at $1.14 per share, way ahead of the Zacks Consensus Estimate of 34 cents. With this the company returns to its profit trend after incurring a loss in the prior quarter due to the Mitsubishi UFJ Financial Group Inc. (MTU) preferred stock conversion. The company had earned 5 cents per share from continuing operations in the year-ago quarter.
A significant benefit from the widening of debt-related credit spreads and Debt Valuation Adjustment (DVA) primarily made it possible for the company to report such impressive results.
The earnings per share calculation accounted for positive revenue of $3.4 billion or $1.12 per share related to these nonrecurring items.
Without this positive impact, Morgan Stanley would have earned 2 cents per share from its continuing operations.
Considering discontinued operations, Morgan Stanley reported net income of $1.15 per share, compared with net loss of 7 cents in the prior-year quarter.
Core results benefited from revenue growth in Institutional Securities and Global Wealth Management Group. But the performance of the Asset Management segment was weak. Also, investment banking revenues remained feeble. Though the quarter experienced improved interest and non-interest revenues, higher non-interest expenses were the headwinds.
With robust M&A activity, Morgan Stanley maintained rank #1 in global completed M&A and rank #2 in global announced M&A during the quarter. The company also ranked #2 in global IPOs and global Equity.
Quarter in Detail
Net revenue for the quarter increased 7% sequentially and 46% year over year to $9.9 billion. This also compares favorably with the Zacks Consensus Estimate of $7.4 billion. The total top-line figure included positive revenue of $3.4 billion pertaining to changes in the company’s debt-related credit spreads and DVA, compared with negative revenue of $731 million a year ago.
Morgan Stanley recorded a net interest income of $140 million, compared with net interest expense of $72 million in the prior quarter and net interest income of $103 million in the prior-year quarter. The improvement was primarily a result of lower interest expense.
Total non-interest revenues increased 4% sequentially and 46% year over year to $9.8 billion. Substantially higher trading revenue and improved commissions and fees were primarily responsible for the growth. However, lower investment banking revenues were the dampeners.
Total non-interest expenses decreased 15% sequentially but increased 4% year over year to $6.2 billion. Total compensation expenses decreased 21% sequentially but remained flat year over year at $3.7 billion, while total non-compensation expenses decreased 5% sequentially and increased 10% year over year to $2.5 billion. Morgan Stanley’s compensation to net revenue ratio for the reported quarter was 37% compared with 50% in the prior quarter and 54% in the year-ago quarter.
Segment Results
Institutional Securities pre-tax income from continuing operations was $3.4 billion compared with $241 million in the prior-year quarter. Net revenue in this segment was $6.4 billion, up 123% from $2.9 billion in the year-ago quarter.
Global Wealth Management pre-tax income from continuing operations was $362 million, up 29% from $281 million in the year-ago quarter. Net revenue was $3.3 billion, up 5% from $3.1 billion in the year-ago quarter. The increase reflects higher asset management revenues and commissions partly offset by net losses from investments associated with the firm’s deferred compensation and co-investment plans.
Asset Management pre-tax loss from continuing operations was $117 million, compared with an income of $279 million in the year-ago quarter. Net revenue for the reported quarter was $215 million, down 73% from $802 million in the year-ago quarter.
As of September 30, 2011, total assets under management were $268 billion, up from $266 billion as of September 30, 2010, reflecting net customer inflows in Morgan Stanley’s liquidity funds, partly offset by lower market levels.
Capital Ratios
At September 30, 2011, book value per share was $31.29, up from $30.17 at June 30, 2011. Tangible book value per share was $27.79, up from $26.61 at June 30, 2011.Morgan Stanley’s Tier 1 capital ratio, under Basel I, was approximately 15.1% and Tier 1 common ratio was approximately 13.1%.
Dividend Update
Concurrent with the earnings release, Morgan Stanley declared a quarterly dividend of 5 cents per share. The dividend will be paid on November 15 to shareholders of record on October 31.
Position of Competitors
Among Morgan Stanley’s close competitors,JPMorgan Chase & Co. (JPM) and Citigroup Inc. (C) upheld the banking banner with better-than-expected results. But JPMorgan failed to impress like it usually does. Citigroup excelled with lower losses from loans with more customers paying their bills on time and an accounting gain related to the valuation of its own debt. JPMorgan buckled under the weakness in the wider economy during the quarter and related pressures on the sector.
The results of Bank of America Corporation (BAC) and The Goldman Sachs Group Inc. (GS) were however shoddy. The sale of non-core assets and accounting gains made it possible for BofA to swing to profit. But excluding nonrecurring items, the company would have incurred a loss. Goldman Sachs reported a significant third quarter loss, driven by sharp drops in underwriting and trading revenue. Goldman’s results also suffered from souring investments in stocks, bonds and other holdings.
Our Viewpoint
We expect the company’s restructuring initiatives to reduce balance sheet risk and improve its valuation over time. Moreover, its inorganic growth initiatives continue to be significant growth drivers. Nevertheless, there are concerns related to the company’s financials being marred by new regulatory requirements and intense pricing competition. We are also concerned aboutits inability to enhance shareholder value.
Morgan Stanley currently retains a Zacks #5 Rank, which translates into a short-term Strong Sell rating.
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