Earnings Streak Continues for Morgan Stanley

Continuing with its trend of delivering positive earnings surprise since the last four quarters, Morgan Stanley’s (MS) third-quarter 2013 earnings from continuing operations of 50 cents per share, outpaced the Zacks Consensus Estimate of 43 cents. Moreover, this compared favorably with 28 cents earned in the prior-year quarter.

Better-than-expected results were driven by top-line growth and lower-than-expected expenses. Moreover, an increase in net revenue across all segments and improved asset position were the tailwinds. However, lower client activity and a fall in market volumes for all products led to a decline in Fixed Income & Commodities sales and trading results. Also, deterioration in capital ratios was a dampener.

Including debt-related credit spreads and Debt Valuation Adjustment (DVA), net income applicable to Morgan Stanley was $880 million or 45 cents per share. This marks a considerable improvement from a net loss of $1.05 billion or 55 cents per share in the year-ago quarter.

Behind the Headlines

Net revenue (excluding DVA adjustments) for the quarter was $8.1 billion, up 7% year over year. Moreover, it outpaced the Zacks Consensus Estimate of $7.8 billion. After taking into consideration the negative revenues pertaining to changes in Morgan Stanley’s debt-related credit spreads and DVA, net revenue grew 50% year over year to $7.9 billion.

Net interest income was $111 million in the reported quarter, compared with a negative net interest income of $155 million in the year-ago quarter. The year-over-year improvement primarily stemmed from 22% fall in interest expenses.

Total non-interest revenues grew 44% year over year to $7.8 billion. All the non-interest income components grew from the prior-year quarter.

Total non-interest expenses were $6.6 billion, down 3% from the previous-year quarter. Morgan Stanley’s compensation to net revenue ratio for the reported quarter was 50%, compared with 74% in the year-ago quarter.

Segment Performance

Institutional Securities (:IS) reported pre-tax income from continuing operations of $371 million, compared with pre-tax loss of $1.9 billion in the prior-year quarter. Net revenue was $3.7 billion, up significantly from $1.5 billion in the year-ago quarter. Further, excluding DVA, net revenue was $3.8 billion, rising 3% on a year-over-year basis.

Wealth Management (WM) pre-tax income from continuing operations was $668 million, increasing substantially from $247 million in the year-ago quarter. Net revenue was $3.5 billion, improving 8% from the year-ago quarter, reflecting higher asset management fees and transactional revenues.

Investment Management (IM) pre-tax income from continuing operations was $300 million, up 52% year-over-year. Net revenue was $828 million, up 32% from the year-ago quarter. The rise was driven by gains on investments in the Merchant Banking and Real Estate Investing businesses.

As of Sep 30, 2013, total assets under management or supervision were $360 billion, up 9% from $331 billion as of Sep 30, 2012. The rise primarily reflected positive flows and market appreciation.

Capital Ratios

As of Sep 30, 2013, book value per share was $32.13, up from $30.53 as of Sep 30, 2012. Tangible book value per share was $26.96, up from $26.65 as of Sep 30, 2012.

Morgan Stanley’s Tier 1 capital ratio, under Base lI, was 15.3% and Tier 1 common ratio was 12.6% compared with 16.9% and 13.9%, respectively in the year-ago quarter.

Capital Deployment Actions

Along with the earnings release, Morgan Stanley declared a quarterly dividend of 5 cents per share. The dividend will be paid on Nov 15 to shareholders of record as of Oct 31.

During the reported quarter, Morgan Stanley repurchased nearly 4.5 million shares worth $123 million. Earlier in July, the company had received no objection from the Federal Reserve to buy back shares. The company has authorized repurchase of shares worth up to $500 million through Mar 31, 2014.

Performance of Other Major Banks

Among other banking giants, The Goldman Sachs Group, Inc. (GS), Wells Fargo & Company (WFC) and Bank of America Corporation (BAC) reported better-than-expected third-quarter results, upholding the image of the banking sector.

Banks have been reporting strong results, primarily on the back of favorable macroeconomic elements. Reduced non-interest expenses and lower provision have been the primary growth drivers for banks this time around.

Our View

Morgan Stanley’s initiatives to offload its non-core assets for lowering balance sheet risks and shifting focus on the less capital incentive IM and WM segments are commendable. Further, in Jun 2013, the company purchased the remaining 35% stake in MSWM JV from Citigroup Inc. This stake buy will help to diversify the company’s revenue base and stabilize its earnings, going forward.

Additionally, the approval of Morgan Stanley’s share repurchase plan reinforces its strong capital position. Moreover, there are high chances of dividend hikes in the future, provided the company receives the Fed’s consent for the same.

Moreover, Morgan Stanley’s organic and inorganic growth initiatives continue to be significant growth drivers. The company remains focused on diversifying its revenue base by expanding its footprint in economies that are less impacted by the financial crisis and the European debt crisis.

However, there are concerns related to Morgan Stanley’s financials being marred by new regulatory requirements and the intense pricing competition. Moreover, stringent capital norms may somewhat lower the company’s flexibility with respect to its investments and lending volumes.

An investor with the ability to absorb risks related to market volatility will not likely be disappointed with investments in Morgan Stanley in the long run. The company’s fundamentals are highly promising with a diverse business model, a stable balance sheet and strong capital position.

Currently, Morgan Stanley carries a Zacks Rank #3 (Hold).

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