Morgan Stanleyreported sharply lower quarterly earnings on Wednesday after absorbing $2.3 billion of write-downs, but resilient trading results helped the No. 2 U.S. investment bank beat Wall Street's reduced expectations by a wide margin.
By several measures, Morgan had the best quarter among the big Wall Street banks, generating more profit than arch-rival Goldman Sachs , suffering the smallest year-over-year profit drop and posting a 20 percent return on equity.
The results give a boost to Chief Executive John Mack, trying to rally a bank that recorded $9.4 billion in mortgage trading losses last year and steer it through the most difficult market environment in decades.
They also deliver a dose of good news to a market shaken by the collapse of No. 5 investment bank Bear Stearns and which had been prepared for more signs of distress. Goldman and Lehman Brothers sparked a rally in bank stocks on Tuesday by posting surprisingly strong results and easing worries about new failures.
"This was a pretty strong quarter for (Morgan Stanley) in this environment," said Jeff Harte, brokerage analyst at Sandler O'Neill & Partners in Chicago. "Trading was a lot stronger than I was looking for, which implies they were well positioned."
Morgan's income from continuing operations fell 42 percent to $1.55 billion, or $1.45 a share, in the fiscal first quarter ended Feb. 29, from $2.31 billion, or $2.17 a share, a year earlier. Revenue fell 17 percent to $8.3 billion.
The results trounced the analysts' average forecast of $1.03 a share on revenue of $7.3 billion, according to Reuters Estimates. Morgan shares, which jumped 19 percent Tuesday, rose 7 percent to $45.88 in morning New York Stock Exchange trade Wednesday.
"They have gone a long way toward cleaning up and certainly delivered a very solid quarter," Merrill Lynch analysts said in a note. "We expect the rally in the brokers to continue, especially for Morgan Stanley."
Goldman analyst Bill Tanona added Morgan to the firm's "conviction buy" list and expects the shares to reach $50 in the next six months.
Morgan's investment banking and trading division produced its third-best quarter ever, although revenue fell 14 percent to $6.2 billion from last year's boom-time results.
Fixed-income trading posted its second-best quarter ever at $2.9 billion of revenue, down 15 percent from a year ago, on record results in the trading of interest rates, credit and currencies and a second-best effort in commodities. These gains were offset by $1.2 billion of proprietary mortgage write-downs.
Morgan also reported $1.1 billion of net losses from marking down leveraged loans, whose value has been hurt by the credit crunch.
"There are near-term cyclical challenges, but none of it challenges the long-term secular growth opportunities for the firm," Chief Financial Officer Colm Kelleher said in an interview. "We think we can navigate the choppy waters safely on the back of our client franchise."
Kelleher, who has maintained a cautious view of the markets since he took over as CFO last fall, said the bank has reduced its exposure to mortgages, loans and other assets, pared down balance sheet leverage and boosted reserves of cash.
Elsewhere at the company, equity trading revenue surged 50 percent to $3.3 billion in the first quarter, fueled by volatile stock markets and derivatives.
These strengths were offset by weaker investment banking -- advisory fees jumped 19 percent but underwriting fell sharply -- and a $161 million loss in an asset management division still struggling to rebuild its laggard retail business.
The bottom line, to be sure, enjoyed a $850 million accounting gain on the lower value of its debt as well as a sharply lower tax rate. Kelleher said he will continue to suspend buyback activity until markets improve.
Wall Street banks have been buffeted by a breakdown across financial markets, which eroded the value of many securities and sapped the confidence of investors.
The Federal Reserve intervened to support brokers last week and bailed out a nearly insolvent Bear Stearns, nudging the No. 5 investment bank to accept a fire-sale $2-per-share takeover offer from JPMorgan Chase .
Morgan's net income last year was $2.67 billion, including results from two businesses the bank has since spun-off or sold: U.S. credit card company Discover Financial and British brokerage Quilter.
Its head count fell by 1,206, or 2 percent, to 47,050 during the first quarter. Kelleher declined to forecast hiring plans this year.