Morgan Stanley earnings plunge despite asset sales

Morgan Stanley has said quarterly earnings dropped by more than 50 per cent on trading losses and a slowdown in investment banking, even after the investment bank realised US$1.43 billion of pretax gains from asset sales.

Morgan Stanley's shares dropped as much as 7.8 per cent as analysts questioned the sustainability of the bank's earnings, which came mainly from selling businesses.

The second-largest US investment bank reported income from continuing operations of US$1.03 billion, or 95 cents a share, for its fiscal second quarter, ended May 31, down from US$2.36 billion, or US$2.45 a share, a year earlier.

Net revenue fell 38 per cent to US$6.5 billion from the same quarter last year, dragged lower in part by a contrarian bet on energy that didn't pan out and actions by a London trader that violated company policy.

"This has been an unusually stressed quarter," Morgan Stanley Chief Financial Officer Colm Kelleher told Reuters.

Some analysts said the investment bank's core earnings were just a few pennies per share, falling far short of average analyst expectations of 92 cents.

Most of the company's earnings came from two one-time items: a US$698 million pretax gain from the sale of its Spanish wealth management business and a US$732 million pretax gain from the sale of part of its stake in MSCI Inc.

'ALL THE WAY TO SPAIN'

"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? What's going to be the driver of earnings growth going forward?" said Matt McCormick, a stock analyst at Bahl & Gaynor Investment Counsel in Cincinnati.

Gains from asset sales helped offset US$245 million of severance related to job cuts, US$436 million of losses from proprietary mortgage trades and US$519 million of net losses on leveraged loans.

Morgan Stanley said the actions of a single London trader who violated company policies resulted in a US$120 million write-down. The trader has been suspended and a full internal review is occurring, Kelleher said on a conference call.

He called the problem an isolated situation.

The credit crunch is battering banks and brokers, which have been forced to write down more than US$400 billion of assets, slash jobs and raise new capital. Morgan Stanley suffered US$9.4 billion of fourth-quarter subprime trading losses and then reported first-quarter earnings that fell by half.

The weak results from Morgan Stanley, together with an announcement by regional bank Fifth Third Bancorp's of a dividend cut and US$2 billion capital increase, sent credit protection costs for banks and brokers higher.

Investors and regulators are pushing banks to cut their assets relative to their capital, a move that should reduce returns for the sector. Morgan Stanley's ratio of assets to tangible equity fell to 25.1, from 27.4 in the first quarter.

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

Revenue dropped in almost every business. Investment banking fees fell by half. Fixed income trading net revenue sank by 85 per cent, reflecting the mortgage losses as well as reductions in other markets.

Equity sales and trading revenue fell 11 per cent to US$2.1 billion, hurt by lower results from Morgan Stanley trading with its own funds.

Kelleher told Reuters that commodity revenues fell on "contrarian" bets placed on energy trades.

"We felt it was the right trade," he said in a phone interview. "It didn't work. Sometimes that happens."

Real estate investment losses led to a pretax loss of US$277 million in Morgan Stanley's asset management division.

The report follows rival Lehman Brothers, which on Monday posted a US$2.8 billion loss, and Goldman Sachs Group, which on Tuesday said profit fell by 11 per cent amid relatively light losses.

Morgan Stanley's results were weak compared with the other two, analysts at Fox-Pitt Kelton wrote on Wednesday.

"Not only was Morgan Stanley's result far below that of Goldman, even Lehman did better in the client franchise," wrote David Trone and Ivy De Dianous.

The news was not all negative. The investment bank's pending deals, a measure of potential future banking earnings, rose in the second quarter, Kelleher said. Morgan Stanley's asset management business experienced inflows of client cash, even as many competitors saw outflows. And a 4 per cent increase in wealth management revenue was better than some analysts expected.

PRESSURE ON MACK

The latest results add 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 a mortgage business at the market's peak.

Morgan Stanley last year sold a US$5 billion equity stake to a Chinese government-controlled fund. It has also cut thousands of jobs and pared down its balance sheet, and Kelleher said on the conference call it could slash payrolls again if the markets deteriorate further.

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

Morgan Stanley's book value, or assets minus liabilities, was US$30.11 per share at the end of the quarter. Morgan Stanley's shares trade at about 1.3 times their book value, less than Goldman's 1.8, but above Lehman's 0.7.

The company's shares were down US$1.35 per cent, or 3.4 per cent, at US$39.25 on the New York Stock Exchange.