Rebound in trading activity drove Morgan Stanley’s (MS) third-quarter 2014 adjusted earnings from continuing operations of 65 cents per share, which surpassed the Zacks Consensus Estimate of 54 cents. Further, it was 30% above 50 cents earned in the prior-year quarter. Also, this was the ninth consecutive quarter in which the company delivered a positive earnings surprise.
Shares of Morgan Stanley rose nearly 4% in the early morning trade, implying that the market is encouraged with the company’s performance. The price reaction during the full trading session will give a better idea about how investors accepted the results.
Results benefited from a drastic improvement in net interest income and higher fee income. These were, however, partly offset by a slight rise in operating expenses.
More importantly, higher fixed-income, currency and commodities (FICC) trading income, along with a rise in advisory revenues, were the catalysts. Also, increase in the net revenue of all segments, except Investment Management and improved asset position, acted as a tailwind.
However, including debt-related credit spreads, Debt Valuation Adjustment (DVA) and a discrete tax benefit, net income from continuing operations came in at $1.7 billion or 84 cents per share. This was up from $889 million or 44 cents per share in the year-ago quarter.
Performance in Detail
Net revenue (excluding DVA adjustments) for the quarter was $8.7 billion, up 7% year over year. Moreover, it outpaced the Zacks Consensus Estimate of $8.0 billion. After considering the positive revenues pertaining to the changes in Morgan Stanley’s debt-related credit spreads and DVA, net revenue rose 12% year over year to $8.9 billion.
Net interest income was $557 million, up significantly from $110 million recorded in the year-ago quarter, driven by a 28% fall in interest expenses. Further, total non-interest revenue of $8.4 billion increased 7% year over year.
Total non-interest expenses were $6.7 billion, up 1% from the prior-year quarter. The marginal rise was primarily owing to an increase in the compensation and benefits expenses, professional services fees and marketing and business development costs, partially offset by lower information processing and communications, and other expenses.
Morgan Stanley’s compensation to net revenue ratio for the reported quarter was 47% versus 50% in the year-ago quarter.
Segmental Performance
Institutional Securities (IS): Pre-tax income from continuing operations was $1.2 billion, up substantially from $396 million in the prior-year quarter. Net revenue was $4.5 billion, up 21% from the year-ago quarter. Excluding DVA, net revenue was $4.3 billion, climbing 11% on a year-over-year basis. The rise in revenue was largely driven by higher FICC income, advisory revenues and equity sales and trading net revenues.
Wealth Management (WM): Pre-tax income from continuing operations was $836 million, increasing 25% from the year-ago quarter. Net revenue was $3.8 billion, improving 9% from the year-ago quarter driven by a rise in asset management fees. This was, however, partially offset by a fall in transactional revenues.
Investment Management (IM): Pre-tax income from continuing operations was $188 million, down 37% year over year. Net revenue was $655 million, a decline of 21% from the year-ago quarter. The fall was due to lower investment gains and carried interest in the Merchant Banking and Real Estate Investing operations, partly offset by improved results from Traditional Asset Management.
As of Sep 30, 2014, total assets under management or supervision were $398 billion, up 11% from $347 billion as of Sep 30, 2013. The rise primarily reflected positive flows of $7.6 billion and market appreciation.
Capital
As of Sep 30, 2014, book value per share was $34.17, up from $32.13 as of Sep 30, 2013. Tangible book value per share was $29.25, up from $26.96 as of Sep 30, 2013.
Morgan Stanley’s Tier 1 capital ratio (Advanced Approach) was 16.1% versus 15.3% in the year-ago quarter and Tier 1 common capital ratio (transitional) was 14.3% versus 12.6% in the prior-year quarter.
Share Repurchases
During the reported quarter, Morgan Stanley bought back around 5.9 million shares for nearly $195 million. This was part of the share buyback program announced by the company, under which shares worth up to $1 billion can be repurchased, beginning from the second quarter of 2014 through the first quarter of 2015.
Our Viewpoint
Morgan Stanley’s initiatives, to offload its non-core assets in order to reduce balance-sheet risks and shift focus on the less capital-incentive IM and WM segments, are commendable. Further, full control of Morgan Stanley Wealth Management JV has aided in the diversification of the company’s revenue base. This will, in turn, stabilize its earnings going forward.
Additionally, Morgan Stanley has been moving away from the commodity trading business as well. Increased regulatory scrutiny and waning profits are the primary reasons behind shedding this once lucrative business. However, the divestiture of its Global Oil Merchanting Unit to Russia-based Rosneft Oil Company is in jeopardy, following imposition of various sanctions by the U.S. on Russia owing to the Ukraine crisis.
Nonetheless, Morgan Stanley’s organic and inorganic growth initiatives continue to act as significant growth drivers. The company remains focused on diversifying its revenue base by expanding footprint in the emerging economies.
However, there are concerns related to Morgan Stanley’s financials being pressured by new regulatory requirements and intense pricing competition. Also, stringent capital norms may somewhat lower the company’s flexibility with respect to its investments and lending volumes.
Currently, Morgan Stanley carries a Zacks Rank #3 (Hold).
Among other banking giants, JPMorgan Chase & Co. (JPM), Wells Fargo & Company (WFC) and Citigroup Inc. (C) have come out with third-quarter results. Despite the continued tough industry backdrop, all these big banks managed to report decent earnings.
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