Friday, July 22, 2011

Morgan Stanley Comes Up Golden

Morgan Stanley Comes Up Golden

By AARON LUCCHETTI

After a series of missteps, Morgan Stanley found its footing in the second quarter, generating its highest quarterly revenue since 2007 and overtaking rival Goldman Sachs Group in bond trading for the first time since the financial crisis.

.The New York investment bank's surprise performance was driven partly by its decision to take on more risk when trading on behalf of clients during the quarter—a move that contrasts with Goldman's risk-aversion during the same period.

The results were a much-needed win for James Gorman, Morgan Stanley's chief executive, who is under pressure to improve the firm's inconsistent performance and catch up with rivals such as Goldman and J.P. Morgan Chase & Co.

Morgan Stanley reported a quarterly loss of $558 million but that was due to a $1.7 billion charge incurred when Japanese bank Mitsubishi UFJ Financial Group last month restructured its investment in the investment bank. Morgan Stanley's per-share loss of 38 cents was far smaller than the 64 cents expected by analysts, according to Thomson Reuters.

Morgan Stanley shares soared 11.4%, or $2.48, to $24.20 in its biggest one-day percentage gain since early 2009.

"It's hard to remember the last time they were the outperformer," says Jeff Harte, a banking analyst with Sandler O'Neill.

.Morgan Stanley has suffered several fits and starts—especially in its trading business, where it suffered large losses on risky bets—and turned in subpar results when it cut back risk in 2009.

Mr. Harte said the second-quarter results released Thursday were "a step in the right direction, but give me three really good quarters, and I'll say they're definitely there."

Morgan Stanley's quarterly net revenue of $9.3 billion was its highest since the three-month period ended May 2007 and bested analysts' estimates by about 16%. They were especially striking given the weak quarter at Goldman Sachs, which had $7.3 billion in revenue. The two banks' results ended a nine-quarter streak in which Goldman revenue topped Morgan Stanley's, often on the back of savvy trading in stocks, bonds and commodities.

This quarter, Morgan Stanley's revenue beat its bigger rival in bond trading and investment banking. Morgan Stanley's fixed-income and commodity division had net revenue of $2.1 billion, but the number was boosted by a $470 million gain related to its financial exposure to bond-insurance firms. Goldman's fixed-income, currency and commodities division, by contrast, had revenue of $1.6 billion during the quarter.

In stock trading, Morgan Stanley's $1.85 billion in revenue trailed Goldman's $1.92 billion, but the results were Morgan Stanley's best since 2008.

"We're very pleased that we're executing and continuing to build share with clients," said Ruth Porat, Morgan Stanley's chief financial officer, in an interview. She said the firm's gains in trading came in part from efforts to get more business out of existing trading clients across a variety of services from prime brokerage for hedge funds to currency, interest rates and commodity trading.

The firm's stock- and bond-trading results came from taking more risk and increasing the amount of capital its traders can use to serve investors that want to buy and sell securities. Morgan Stanley has been increasing a measure of its trading risk—called "value at risk," or VAR—which attempts to estimate what the firm might lose in a single trading day based on its holdings and past market volatility.

In the second quarter, the firm's VAR increased on average to $145 million from $121 million in the first quarter and $139 million during the second quarter of 2010. Ms. Porat noted in a call with analysts that the risk measurement declined toward the end of the second quarter as investors pulled back from trading due to fiscal concerns in Europe and the U.S.

Morgan Stanley's investment-banking business brought in $1.7 billion, up 40% form the previous quarter and 57% from the second quarter of 2010. Both merger-advisory and underwriting fees rose sharply as the firm benefited from winning mandates to advise on large stock offerings and takeover deals during the quarter.

Unlike its trading divisions, Morgan Stanley's investment-banking department has stayed near the top of the pack, taking advantage of the banking consolidation that followed the 2008 crisis and left fewer competitors. Bear Stearns Cos., Lehman Brothers Holdings Inc. and Merrill Lynch & Co., most notably, went away or were swallowed by bigger commercial banks.

This year, Morgan Stanley has helped lead several big IPOs, such as that of commodities producer Glencore International PLC and social networking firm LinkedIn Corp. Morgan Stanley could also be well positioned if technology IPOs continue to become more popular for fast-growing private companies.

Mr. Gorman said Morgan Stanley was continuing its work to turn around the firm amid "unquestionably challenging markets."

He noted that the firm has made progress on many of the 10 items he felt the firm needed to improve on when he started as CEO in January 2010.


.One item was restructuring the relationship Morgan Stanley forged with Japanese bank Mitsubishi UFJ during the financial crisis. Mitsubishi UFJ made an emergency $9 billion investment in Morgan Stanley that carried a hefty quarterly dividend. Last month, the two firms restructured the investment. Mitsubishi UFJ got a bigger stake, but now owns common shares that don't require Morgan Stanley to pay the high dividend. In addition, Mr. Gorman said, the common stake aligns the two firm's interests better.

Mr. Gorman also indicated he would push for more cost-cutting at the firm's brokerage joint venture with Citigroup. Morgan Stanley, which owns 51% of the joint venture, plans to buy the rest over the next few years. While revenue has steadily grown in the joint venture, progress cutting costs and boosting pre-tax margins to 20% has gone more slowly.

"We remain very focused on expenses in this business," says Mr. Gorman. "Margins must improve and do so soon."

Ms. Porat said the firm would continue to prune some of the firm's underperforming brokers in an effort to increase margins. Overall, the firm would likely keep head count constant or reduce it slightly, mainly through slowing down hires. Some analysts say that Morgan Stanley may not need to cut as many staffers as other Wall Street firms in a difficult environment because it was smaller in some key areas such as trading in 2009 and 2010.

Morgan Stanley "should be less exposed" to some of the macroeconomic weakness, because they have been in a rebuilding mode and come from a weakened base," says Howard Chen, an analyst with Credit Suisse.

"MUFG prospers when Morgan Stanley prospers," said Mr. Gorman.

Write to Aaron Lucchetti at aaron.lucchetti@wsj.com

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