(MS) Morgan Stanley’s Loss Less Than Expected

Morgan Stanley’s (MS) second-quarter 2011 loss from continuing operations came in at 38 cents per share, substantially better than the Zacks Consensus Estimate of a loss of 63 cents. This represents Morgan Stanley’s first quarterly loss after seven consecutive quarters of income since the economic crisis began. The company earned 80 cents from continuing operations in the year-ago quarter.

The conversion of the Morgan Stanley’s Series B Preferred Stock, held by Mitsubishi UFJ Financial Group Inc. (MTU), into common stock had a significant negative impact on its earnings. The earnings per share calculation accounted for a negative adjustment of about $1.02 per share related to the conversion.

Without this negative impact, Morgan Stanley would have earned 64 cents per share from its continuing operations.

Considering discontinued operations, Morgan Stanley reported net loss of $558 or 38 cents per share, compared with net income of $1,906 million or $1.09 in the prior-year quarter.

Strong investment banking performance and revenue growth in all three business segments were impressive. The quarter also witnessed strong client franchises. However, higher interest and non-interest expenses were the headwinds.

With robust M&A activity, Morgan Stanley ranked #1 in global completed M&A and ranked #2 in global announced M&A during the quarter. The company also ranked #2 in global IPOs. Strong performance in equity sales also helped it rank #4 in global equity.

Quarter in Detail

Net revenues for the quarter increased 22% sequentially and 17% year over year to $9.3 billion. This also compares favorably with the Zacks Consensus Estimate of $8.1 billion. Revenue for the reported quarter included positive revenue of $244 million pertaining to changes in the company’s debt-related credit spreads, compared with positive $750 million in the year-ago quarter.

Morgan Stanley recorded a net interest expense of $72 million, compared with net interest income of $1 million in the prior quarter and $141 million in the prior-year quarter. The deterioration was primarily a result of higher interest expense.

Total non-interest revenues increased 23% sequentially and 20% year over year to $9.4 billion. Higher investment banking revenue was primarily responsible for the growth.

Total non-interest expenses increased 9% sequentially and 17% year over year to $7.3 billion. Total compensation expenses increased 8% sequentially and 20% year over year to $4.7 billion, while total non-compensation expenses increased 10% sequentially and increased 12% year over year to $2.7 billion.

Morgan Stanley’s compensation to net revenue ratio for the reported quarter was 50% compared with 57% in the prior quarter and 49% in the year-ago quarter.

Segment Results

Institutional Securities’ pre-tax income from continuing operations was $1.5 billion compared with $1.6 billion in the prior-year quarter. Net revenues in this segment were $5.2 billion, up 15% from $4.5 billion in the year-ago quarter.

Global Wealth Management’s pre-tax income from continuing operations was $322 million, up 56% from $207 million in the year-ago quarter. Net revenues were $3.5 billion, up 13% from $3.1 billion in the year-ago quarter. The increase primarily reflects higher asset management revenues and gains on securities held for sale.

Asset Management’s pre-tax income from continuing operations was $165 million, compared to a loss of $86 million in the year-ago quarter. Net revenues for the reported quarter were $645 million, up 57% from $410 million in the year-ago quarter. The increase reflects gains on principal investments in the Real Estate Investing business and higher results in the Traditional Asset Management business.

As of June 30, 2011, total assets under management were $296 billion, up 21% from $244 billion as of June 30, 2010, reflecting market appreciation and net customer inflows.

Capital Ratios

At June 30, 2011, book value per share was $30.17, down from $31.45 at March 31, 2011. Tangible book value per share was $26.61. Morgan Stanley’s Tier 1 capital ratio, under Basel I, was approximately 16.8% and Tier 1 common ratio was approximately 14.6%.

Dividend Update

On July 19, Morgan Stanley declared a quarterly dividend of 5 cents per share. The dividend will be paid on August 15 to shareholders of record on July 29.

Position of Competitors

Among Morgan Stanley’s close competitors, JPMorgan Chase & Co. (JPM) and Citigroup Inc. (C) reported impressive second quarter results, while the results of Bank of America Corporation’s (BAC) and The Goldman Sachs Group Inc. (GS) were shoddy.

JPMorgan’s second quarter earnings came in substantially ahead of the Zacks Consensus Estimate. The surprising numbers were primarily supported by a substantial slowdown in provision for credit losses and higher net revenue, which more than offset an increase in non-interest expense and lower net interest income.

Citigroup also surpassed the Zacks Consensus Estimate. The better-than-expected results were driven by a drop in provisions for credit losses and lower revenue. However, higher expenses were the downside.

On the other hand, Bank of America’s decision to settle its legacy Countrywide mortgage repurchase and servicing claims had a severe impact on second quarter results. The company’sloss of 90 cents per share was a penny narrower than the Zacks Consensus Estimate and below the earnings of 27 cents in the prior-year quarter. Excluding certain mortgage-related and other nonrecurring items, the company earned 33 cents per share during the reported quarter.

Goldman’ssecond-quarter earnings were significantly below the Zacks Consensus Estimate. The results deteriorated primarily due to a decrease in revenue and poor performance in Institutional Client Services division. However, lower operating expenses partially offset the revenue headwind.

Our Viewpoint 

We anticipate that the restructuring initiatives to reduce balance sheet risk will improve Morgan Stanley’s valuation over time. Moreover, its inorganic growth initiatives continue to be significant growth drivers. Nevertheless, there are concerns related to the company’s financials being marred by new regulatory requirements, intense pricing competitionand its inability to enhance shareholder value.

Morgan Stanley currently retains a Zacks #5 Rank, which translates into a short-term Strong Sell rating.

BANK OF AMER CP (BAC): Free Stock Analysis Report

CITIGROUP INC (C): Free Stock Analysis Report

GOLDMAN SACHS (GS): Free Stock Analysis Report

JPMORGAN CHASE (JPM): Free Stock Analysis Report

MORGAN STANLEY (MS): Free Stock Analysis Report

MITSUBISHI-UFJ (MTU): Free Stock Analysis Report

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