Morgan Stanley Beats, Excluding DVA - Analyst Blog

By Zacks | October 18, 2012 AAA

Morgan Stanley's (MS) third quarter 2012 earnings from continuing operations came in at 28 cents per share, marginally surpassing the Zacks Consensus Estimate of 24 cents. This is also significantly ahead of the prior-year quarter earnings of 2 cents.

Adjusting the debt-related credit spreads and Debt Valuation Adjustment (DVA), Morgan Stanley reported net loss of $1.03 billion or 55 cents per share from continuing operations. The company earned $2.13 billion or $1.14 per share from continuing operations in the year-ago quarter.

Better-than-expected results for Morgan Stanley were attributable to top-line growth (excluding DVA adjustments), partially offset by slight rise in operating expenses. Further, increase in net revenue across all segments was the tailwind for the company.

In September, Morgan Stanley completed the purchase of the additional 14% stake in Morgan Stanley Smith Barney (MSSB) - its brokerage joint venture (JV) with Citigroup Inc. C) - for $1.89 billion. As of September 30, 2012, the company holds a 65% stake in the JV.

Further, Morgan Stanley ranked #1 in global IPOs, while it ranked #2 in global announced M&A.

Performance in Detail

Net revenue (excluding DVA adjustments) for the quarter was $7.6 billion, surging 18% from the year-ago quarter. Net revenue also significantly outpaced the Zacks Consensus Estimate of $6.7 billion. Moreover, after taking into consideration the negative revenue pertaining to changes in Morgan Stanley's debt-related credit spreads and DVA, net revenue declined 46.1% year over year to $5.3 billion.

Morgan Stanley recorded a net interest loss of $157 million compared with net interest income of $145 million in the prior-year quarter. The deterioration primarily resulted from drastic fall in interest income, partially offset by a dip in interest expenses.

Total non-interest revenues plummeted 43.7% year over year to $5.4 billion. All the non-interest income components, apart from asset management, distribution and administration fees as well as investment banking fees, declined from the prior-year quarter.

Total non-interest expenses were $6.8 billion, rising 10.5% from $6.1 billion in the previous-year quarter. The increase was attributable to higher total compensation and non-compensation expenses.

Morgan Stanley's compensation to net revenue ratio for the reported quarter was 74%, compared with 37% in the year-ago quarter.

Segment Performance

Institutional Securities reported pre-tax loss from continuing operations of $1.9 billion compared with pre-tax profit of $3.4 billion in the prior-year quarter. Net revenue was $1.4 billion, down 79% from $6.4 billion in the year-ago quarter. However, excluding DVA, net revenue stood at $3.6 billion, up 21.3% on a year-over-year basis.

Global Wealth Management (GWM) pre-tax income from continuing operations was $239 million, down 33% from $356 million in the year-ago quarter. Pre-tax income was adjusted for certain non-recurring costs related to the MSSB integration and the purchase of an additional stake in the JV. Net revenue was $3.3 billion, improving 3% from $3.2 billion in the year-ago quarter, reflecting marginally higher asset management fees.

Asset Management (AM) pre-tax income from continuing operations was $198 million, up from pre-tax loss of $118 million in the year-ago quarter. Net revenue for the reported quarter was $631 million, up significantly from $205 million in the year-ago quarter. The substantial rise in net revenue was driven by robust results in the Traditional Asset Management business along with gains on principal investments in the Merchant Banking and Real Estate Investing businesses.

As of September 30, 2012, total assets under management were $331 billion, up 23.5% from $268 billion as of September 30, 2011.

Capital Ratios

As of September 30, 2012, book value per share was $30.53, down from $31.29 as of September 30, 2011. Also, tangible book value per share was $26.65, down from $27.79 as of September 30, 2011.

Morgan Stanley's Tier 1 capital ratio, under Basel I, was approximately 16.7% and Tier 1 common ratio was approximately 13.7%.

Dividend Update

Concurrent with the earnings release, Morgan Stanley declared a quarterly dividend of 5 cents per share. The dividend will be paid on November 15 to shareholders of record on October 31.

Performance by Peers

Like Morgan Stanley, its close peers - JPMorgan Chase & Co. (JPM), The Goldman Sachs Group Inc. (GS), Bank of America Corporation (BAC) and Citigroup - also reported substantially better-than-expected third quarter results. For JPMorgan and Goldman, results primarily benefited from improved revenue. Moreover, for Citigroup and Bank of America, positive results were mainly aided by reduction in loan loss provisions.

Our Viewpoint

We expect Morgan Stanley's initiatives to offload its non-core assets will help reduce balance sheet risk and shift focus on less capital incentive AM and GWM segments. Also, a 14% stake buy in the MSSB JV will diversify its revenue base and stabilize the company's earnings forward.

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

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

An investor with an appetite to absorb risks related to the market volatility should not be disappointed with investments in Morgan Stanley over the long term. The company's fundamentals remain highly promising with a diverse business model and a stable balance sheet and capital position. Nevertheless, we remain concerned about the company's ability to enhance shareholder value in the near term as it did not plea for any additional capital deployment plans.

Morgan Stanley currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. Also, we maintain a long-term Neutral recommendation on the stock.

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