Morgan Stanley reported better-than-expected adjusted quarterly earnings on Thursday as it boosted revenue from trading bonds, long a sore spot for the investment bank.
The bank's debt ratings were downgraded over the summer to three steps above junk. The cut was smaller than many observers had feared, and Morgan Stanley's trading business picked up steam in the third quarter after sagging ahead of the downgrade, Chief Financial Officer Ruth Porat said.
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"Clients re-engaged and continued to re-engage throughout the quarter," Porat told Reuters in an interview.
Morgan Stanley laid off hundreds of its fixed-income trading staff after the financial crisis, leaving it poorly positioned to benefit from the frenzied bond trading that occurred in 2009 and 2010.
For more than three years, executives have been talking about boosting market share in fixed-income trading. Last year the bank set a target of raising its share of Wall Street's bond trading revenue pie by 2 percentage points. At the time, analysts said its share was 6 percent.
Progress has been halting, but on Thursday Morgan Stanley said bond-trading revenue in the third quarter climbed 33 percent from a year earlier to $1.5 billion, excluding the accounting impact of changes in value of the bank's debt.
Overall adjusted trading revenue rose 21 percent, to $3.6 billion, with gains in interest rate and credit trading. Most of the gains came from increased client activity, rather than rising asset values, Porat said.
Since setting out its market-share gains target, Morgan Stanley management has also made strategic decisions about how to adjust its bond-trading business to lessen capital needs.
The bank is more focused on areas of the market that can be automated and where securities can easily be sold to clients instead of being kept in inventory, such as U.S. government debt. The firm plans to reduce risk-weighted assets by more than $100 billion from their September 30, 2011, level, in part by exiting riskier, more complex trading businesses.
Morgan Stanley is "very much on track" to meet that target, Porat said, but declined to specify the reductions so far. She also said the company stands by its market-share gains target.
Also helping third-quarter earnings was a reduction in compensation as a portion of revenue in Morgan Stanley's trading and investment banking business. The company paid out 45 percent of net revenue, excluding accounting swings, to employees, down from 49 percent in the previous quarter and 51 percent a year ago.
In an article published earlier this month, Chief Executive James Gorman told the Financial Times that he plans to reduce compensation at the firm.
Morgan Stanley shares were down 1 percent to $18.29 in late-morning trading.
Overall, Morgan Stanley's income from continuing operations totaled $561 million, or 28 cents per share, in the third quarter, compared with $64 million, or 2 cents per share, a year earlier.
On that basis, analysts had been expecting 24 cents per share, according to Thomson Reuters I/B/E/S. Morgan Stanley shares fell 1.7 percent to $18.17.
The main driver of the higher adjusted earnings were improvements in its institutional securities business, which includes trading and investment banking.
Pretax income in that business, excluding debt valuation adjustments, was $345 million, up from $37 million a year ago.
Morgan Stanley's global wealth management business also showed improvement, excluding one-time integration costs and buying an additional stake in a retail brokerage joint venture with Citigroup Inc . The adjusted pretax profit margin for the business rose to 13 percent from 11 percent. Management has targeted a pretax margin in the "mid-teens" for wealth management by next year.
Overall, Morgan Stanley lost money in the third quarter due to a $2.3 billion accounting charge to reflect an increase in the value of the bank's debt.
Including that charge, Morgan Stanley lost $1 billion, or 55 cents per share, in the quarter.
U.S. accounting rulemakers are changing the rule that requires earnings to reflect changes in a bank's debt values. Analysts and investors tend to ignore income and losses from debt value adjustments because the adjustments swing wildly but have little impact on a bank's daily business.
(Reporting By Lauren Tara LaCapra; Editing by John Wallace)