BL: Morgan Stanley Profit Drops on Debt Losses, Trading (Update2)
By Christine Harper
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June 18 (Bloomberg) -- Morgan Stanley's earnings dropped 57 percent in the second quarter as revenue from asset management and investment banking declined while equities and fixed-income traders generated less profit.
The second-biggest U.S. securities firm fell as much as 7.8 percent in New York trading after reporting that earnings from continuing operations sank to $1.03 billion, or 95 cents a share, from $2.36 billion, or $2.24, a year earlier. The sale of a Spanish wealth management business and part of the company's stake in equity index provider MSCI Inc. propped up the results.
Chief Executive Officer John Mack said in a statement that ``difficult market conditions and lower levels of client activity'' depressed earnings, as the firm suffered writedowns on bonds backed by real estate and leveraged loans and traders made bad bets with the company's money. Lehman Brothers Holdings Inc. reported its first loss in 14 years earlier this week and Goldman Sachs Group Inc. said yesterday that earnings fell for a second straight quarter.
``For Morgan Stanley, one of the challenges in modeling the company is they've had some pretty erratic trading results over recent quarters,'' Roger Freeman, an analyst at Lehman Brothers, who has an ``equal weight'' rating on the stock, said in a Bloomberg Radio interview. ``It's a little tough to get behind those trading results and they seem to have been more negative than positive this quarter.''
Debt Writedowns
Morgan Stanley dropped $2.14, or 5.3 percent, to $38.45 at 10:06 a.m. in New York Stock Exchange composite trading, after sinking as low as $37.42. The shares were down about 24 percent this year through yesterday, compared with the 23 percent decline of the 11-company Amex Securities Broker/Dealer Index. Goldman had fallen 17 percent and Lehman had slumped 62 percent.
Morgan Stanley's net income fell to $1.03 billion, or 95 cents a share, from $2.58 billion, or $2.45, a year ago. Revenue fell 38 percent to $6.51 billion in the three months ended May 30 and the firm's annualized return on equity, a measure of how well shareholders' money is reinvested, declined to 12.3 percent from 29.4 percent a year ago. That compares with Goldman's second-quarter return on equity of 20.4 percent.
Morgan Stanley's fixed-income revenue decreased 85 percent to $414 million, after losses of $436 million on mortgage- related trades and $519 million from leveraged loans and related hedges. Lehman reported a negative $3 billion of fixed-income revenue and Goldman's dropped 29 percent to $2.38 billion. All the firms are based in New York.
Job Cuts
Colm Kelleher, Morgan Stanley's chief financial officer, said in an interview today that the firm suspended a credit trader in London for incorrectly valuing his positions. The firm said it made a $120 million ``negative adjustment'' related to the trades after discovering the error in May.
Banks and brokers have taken more than $392 billion of writedowns and credit losses since the beginning of last year as mortgage-backed securities, collateralized debt obligations, leveraged loans and other fixed-income assets dropped in value. Morgan Stanley reported its first loss as a public company in December after $9.4 billion of writedowns on failed mortgage- related investments.
Morgan Stanley, led by the 63-year-old Mack, announced plans last month to reduce headcount by as much as 5 percent. The company has eliminated at least 3,000 jobs since October.
``We're expecting continued weakness across all their business units,'' William Fitzpatrick, an equity analyst at Optique Capital Management Inc. in Racine, Wisconsin, which manages $1.6 billion, said before the earnings report. ``It's going to take some time for these markets to really improve.''
`Timing Wrong'
Morgan Stanley, which dominates commodity trading with Goldman, said revenue from the business fell in the quarter as the firm lost money on North American electricity and earned less from trading oil liquids. Morgan Stanley, like Goldman, doesn't provide separate income figures for commodities. Crude oil futures doubled in the year to May 30, and the price of materials from gold to corn soared to record highs.
``We took a contrarian view on some positions in the energy sector and it didn't work out for us,'' Kelleher said. ``Our traders, who have a very good track record on this, frankly got the timing wrong.''
Proprietary bets also hurt revenue from equity trading. The division, which produced a record $3.3 billion in the first quarter, reaped $2.1 billion in the second quarter, an 11 percent decrease from a year earlier. The Standard & Poor's 500 Index climbed 5 percent during the quarter.
Tier 1 Ratio
Investment banking revenue, which includes merger advisory fees and income from underwriting stock and bond offerings, fell 49 percent to $875 million.
Morgan Stanley advised on $191 billion worth of takeovers completed during the three months ended May 30, down from $287 billion in the same period a year earlier, according to data compiled by Bloomberg. The firm was fifth among managers of global equity offerings during the quarter, Bloomberg data show.
Asset management revenue tumbled 68 percent to $488 million as funds under management advanced 8 percent to $605 billion. Revenue from global wealth management, the firm's retail brokerage unit, rose 48 percent to $2.43 billion, because of the sale of the Spanish unit. Excluding the sale, which yielded $698 million, revenue increased 4 percent.
Morgan Stanley said it also gained $732 million from the sale of shares in MSCI, the index provider.
The company ended the second quarter with $169 billion in total liquidity, which reflects cash and liquid securities, at the parent and subsidiary level, Kelleher said. That's up from $125 billion in the first quarter, he said.
The company's so-called Tier 1 ratio, which bank regulators monitor to gauge a lender's ability to withstand loan losses, was between 11.5 percent and 12 percent in the quarter, Kelleher said. Yesterday Goldman said its Tier 1 ratio was 10.8 percent.
Morgan Stanley reduced gross leverage, or reliance on debt, to 25.1 times from 27.4 times and adjusted leverage to 14.1 from 16, Kelleher said.
``We've seen nothing that made us want to move from our jog back to a run on risk,'' he said.
To contact the reporter on this story: Christine Harper in New York at charper@bloomberg.net.
Last Updated: June 18, 2008 10:12 EDT
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