Investors Love Morgan Stanley As It Beats Earnings On Better Trading Results

The investment bank finished megabank earnings week by exceeding analysts' expectations for profit and revenue.

Morgan Stanley, the last big bank to report earnings, comfortably exceeded analysts' expectations, with its profit rising to $1.71 billion, or 84 cents per share, after an accounting adjustment. In the third quarter of last year, Morgan Stanley only earned $906 million. The bank's profits were helped out by a tax benefit of $237 million that added $.12 to its earnings per share.

The bank's revenue still increased, though not as much, to $8.9 billion from $8.1 billion last year thanks partially to a return of bond and commodities trading that buoyed results across all of Morgan Stanley's big-bank peers.

Investors and analysts have been impressed with the increasing size and strenghth of Morgan Stanley's wealth and investment management business, buoyed by tthe 2013 acquisition of its brokerage co-venture with Citigroup called Smith Barney. In the third quarter, its wealth management revenues of $3.8 billion were 43% of its total revenue, a proportion far greater than that of Goldman Sachs' investment management businesses. The revenues also grew 9% from a year ago and now Morgan Stanley has $2 trillion in client assets.

Analysts polled by Bloomberg expected Morgan Stanley, one of two remaining independent big investment banks along with Goldman Sachs, to earn $.54 per share with profits of $1.06 billion and revenue of $8.16 billion. All those numbers were comfortably exceeded — even with accounting adjustments and the tax benefit stripped out, Morgan Stanley still beat its earnings per share estimate by 11 cents.

While most banks beat expectations and saw profits grow when they reported their earnings for the third quarter, they didn't always get a favorable reaction from investors in early trading. This was not the case for Morgan Stanley. Nomura analyst Steven Chubak wrote in a note that "strong revenue beats" in investment banking and "continuing progress" in wealth management "should drive positive estimate revisions" and that "shares should react well to the result."

And they have, Morgan Stanley's shares finished the day up at $33.22, up 2.12% or $.69. In contrast, Goldman Sachs also substantially grew its revenue and profits in the quarter and beat analysts' expectations but saw its stock fall 2.6% as investors thought its earnings were "low quality" because of the outsize contribution of its own investment business.

"Morgan Stanley has delivered another quarter of earnings growth and strong performance based on consistent execution for our clients," Morgan Stanley chairman and chief executive officer James Gorman said in a statement, alluding to the pick up in trading, merger, and IPOs that helped Morgan Stanley's investment bank business see its revenues rise to $4.3 billion from $3.9 billion in the third quarter of last year.

Morgan Stanley's revenue from equity underwriting — marketing and selling new stock of its corporate clients — almost doubled, hitting $464 million, up from $236 million a year ago. It had similiar success in advising on mergers, with advisory revenues rising 43% to $392 million.

Because of current and potential future regulations that discourage holding large amounts of bonds to trade and banks funding themselves short-term debt that investment banks typically rely on, Morgan Stanley has been on a mutli-year project to shore up what its chief executive officer and chairman James Gorman calls the "ballast" — wealth management — and let the more volatile, risky businesses, what he calls "the engine room" drive profits when markets are moving more. The investment and wealth management business require less precious capital to be run and so have become more attractive as international and domestic rules have required banks to fund their businesses with less borrowing.

The third quarter was such a time when markets started moving again. At a confernce last month, Morgan Stanley's chief financial officer Ruth Porat said that trading activity had "picked up in June, persisted through much of July." That activity presumably persisted through September as Morgan Stanley's fixed income and commodities trading businesss had revenue of $997 billion, a 19.5% jump over the $835 million it generated in the third quarter of last year thanks to what the bank described as "lower client activity." While the increase is notable, the revenues are still well below Goldman Sachs, which had over $2 billion in fixed income and commodities trading revenues.

Morgan Stanley attributed the jump to more activity in trading in currencies and securitized products — investment securities assembled out of loans or other streams of payments — while it had lower results in commodities trading and investment products based on debt. Many banks saw better currency trading results as the US dollar began to rise in value from other currencies, especially in the developing world.

Like all banks, however, Morgan Stanley has had to deal with choppy markets this month, especially in the last week. Investors have started to doubt whether growth will continue globally, althought economic data in the U.S. remains promising. "We are well positioned to create superior returns for our shareholders, particularly as the U.S. economy continues to strengthen," Gorman said.