Morgan Stanley Trades Its Way Past Goldman -- 3rd Update

By Liz Hoffman Features Dow Jones Newswires

Morgan Stanley rode a boost in debt trading to surpass rival Goldman Sachs Group Inc. and join other big Wall Street firms in posting strong results to start the year.

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The firm reported a first-quarter profit of $1.93 billion, or $1 a share, on revenue of $9.75 billion, all above analyst estimates. The results were also well ahead the prior year's quarter, which was a time of tumult for all Wall Street firms.

Morgan Stanley's shares climbed more than 2% Wednesday.

The biggest surprise was $1.71 billion in revenue from Morgan Stanley's fixed-income desk, which trades corporate and government bonds, currencies and commodities. For years the runt of the Wall Street litter, the business is showing steady progress after a leadership change and a raft of layoffs last year.

The unit has now strung together four quarters of $1 billion-plus revenue, a goal cautiously laid out 10 months ago by Chief Executive James Gorman. And this quarter, the fixed-income desk added another feather to its cap: besting Goldman, which reported $1.69 billion in fixed-income trading revenue.

Morgan Stanley has topped Goldman in that business just one other time since the financial crisis, during a tumultuous stretch in the summer of 2011 when skittish Goldman executives pulled back on trading.

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The rivalry between the two firms is decades old and has persisted even as their business models have diverged, with Morgan Stanley diving headlong into its retail brokerage while Goldman stuck to its banking and trading guns.

Morgan Stanley's success on the fixed-income front only underscored the severity of Goldman's first-quarter stumble. On Tuesday, that firm's first-quarter report shocked investors with a year-on-year decline in overall trading revenue, while fixed-income revenue was flat with the prior year.

Other banks with big trading arms such as J.P. Morgan Chase & Co., Bank of America Corp. and Citigroup Inc. had posted double-digit percentage gains in these areas.

Morgan Stanley's trading gains also raised more questions for investors about what might have gone wrong at Goldman. While that firm cited slow trading in commodities and corporate credit, Morgan Stanley finance chief Jonathan Pruzan said corporate bonds, interest-rate products and commodities saw strong demand.

With its latest results, Morgan Stanley hit several targets Mr. Gorman had set publicly. Its return on equity, a closely watched measure of profitability, was 10.7%, finally beating a 10% goal. It would have been 10% without the benefit of an accounting change that lowered its tax payments in the quarter, a spokesman said.

And the firm's giant wealth-management business posted a 24% profit margin, a record and safely inside the raised bar set by Mr. Gorman two years ago. The margin, though, still trailed the 27% posted for the first quarter by its main rival, Bank of America's Merrill Lynch unit.

One factor helping Morgan Stanley was a spike in interest income. This was the fruit of a push across the brokerage business to lend more.

Loans in the division rose 20% to $70 billion. Mr. Pruzan said growth was split across the bank's three main products: mortgages, loans backed by securities portfolios, and tailored loans secured by art, business interests and other valuables.

Few Wall Street firms stand to gain more from the combination of rising interest rates and a rising stock market than Morgan Stanley, which manages trillions of dollars of client money across stocks, bonds and other assets. "In these types of markets our business performs well," Mr. Pruzan said in an interview. "We clearly have to prove it the rest of the year."

Meanwhile, the firm kept a lid on costs. Excluding compensation, which rises in lockstep with revenue, expenses rose just $100 million while revenue rose $2 billion.

"Solid as a rock," Steven Chubak, an analyst with Instinet, wrote in a note to clients.

The focus on costs has occurred as the bank has rejigged its trading operations. In 2016, Chief Operating Officer Colm Kelleher tapped Edward Pick, the bank's equity-trading wunderkind, to oversee overall sales and trading. Mr. Pick's deputy, Sam Kellie-Smith, followed as the new head of fixed-income.

Morgan Stanley promptly cut 25% of its fixed-income traders, reducing expenses. A 2015 upgrade to its credit rating made it a more attractive trading partner. Clearer reporting lines have improved communication and morale, traders say.

One area of weakness occurred in the firm's strongest franchise -- equities trading. Revenue in this area fell 1.9% to $2.02 billion versus a year earlier. That business has grappled with lower commissions and more money moving to passive managers that trade less often.

In investment banking, Morgan Stanley and Goldman continue to compete fiercely. Goldman won a tight contest in the first quarter on M&A mandates. Morgan Stanley led the quarter's big underwriting prize, the IPO of messaging service Snap Inc., and earned a fee that was $5 million larger than Goldman's on the deal.

Morgan Stanley's overall investment-banking revenue rose 43%. A triple-digit gain in underwriting more than offset a decline in M&A fees. Mr. Pruzan said the firm's merger pipeline is higher that it was this time in 2016, which ended up being a record for global deal making.

On a call with analysts, Mr. Gorman called the first quarter "one of the strongest quarters in recent history" and "the result of the many difficult decisions" the firm has made.

Write to Liz Hoffman at liz.hoffman@wsj.com

(END) Dow Jones Newswires

April 19, 2017 13:48 ET (17:48 GMT)