Morgan Stanley (MS) Beats Estimates On Strong FICC and Low Comp

Morgan Stanley (MS) Beats Estimates On Strong FICC and Low Comp

Morgan Stanley (NYSE:MS) reported 3Q12 EPS of $0.28 (excluding DVA), which includes $193mn in MSSB integration charges (-$0.07), as well as litigation in the securities business. Consensus of $0.24 didn’t include a large litigation charge, Today’s results as a beat, were driven by a better than- expected top line (securities) and an in-line comp ratio (52% ex-DVA), or possibly lower compensation, as explained below.

Fixed income trading rebounded from a weak 2Q post  Moody’s Corporation (NYSE:MCO), and drove most of the top-line beat ($1.46bn vs GS estimate of $1.2bn). Even normalizing for the Moody’s Corporation (NYSE:MCO)’s negative impact in 2Q, 3Q revenues were up 47% linked quarter vs. 15% for large-peers. Ex DVA, FICC revenues were $1.5 billion, up 47% versus 2Q12.  Analysts estimate an additional $250 million of CVA negative adjustments, in connection with the ongoing impact of the credit rating downgrade last quarter that had a $225 million negative impact on  core FICC revenue in the 2Q, of $1 billion.

Factoring this in, core FICC revenue in 3Q12 is $1.7 billion, up an impressive 72%. The increase appears to be broad-based within rates, FX, and credit. FICC results across the street this quarter have shown a wide deviation, and these results likely put Morgan Stanley (NYSE:MS) at the top of the pack. Fixed income benefited from the heavy issuance calendar, with revenues rising 28% sequentially to $431MM.

Equity tradingof $1.23bn also beat Goldman Sachs Group, Inc.(NYSE:GS) estimates of $1.1bn, which is a 7% QoQ increase, versus closer to flat for peers.

Investment banking in ISG came in at $969mn, up 10% QoQ relative to Goldman Sachs Group, Inc.(NYSE:GS) estimates’ of $850 (-4% QoQ). Most of the beat came on advisory.  Equities retreated to $199MM, down 30% from the prior quarter, due to weak IPO volumes.

Global wealth management showed progress, with stable revenue and a 13% pre-tax margin (ex. integration charges) vs. 11-12% YTD, an important step towards reaching the “mid-teens” target by middle of next year.  GWM posted pretax income from continuing operations of $239MM, but was negatively affected by $193MM in nonrecurring expenses, related to the MSSB buying and further integration costs. Excluding these one time items, GWM’s pretax margin edged higher, sequentially, to 13%. Adviser headcount declined 1% to 16,829, while client assets advanced 4% to $1.8T.

Firmwide comp ratio was 52% ex-DVA, comprised of 45% in ISG vs. 44% in 2Q, and 61% in GWM (ex-integration) vs. 60% in 2Q.  The comp ratio in institutional securities (ex-DVA) was 45%, down from 49% in the 2Q, but slightly ahead of analysts’ 44% forecast. The tax rate also came in a bit higher, at 35.4% versus 33% estimate.

Non-comp expense of $2.8bn vs. $2.4bn in 2Q and consensus estimates of $2.5bn implies several hundred million in litigation this quarter ($0.05-$0.10 EPS).

CAPITAL & LIQUIDITY. Reflective of the 14% ownership increase of MSSB, tangible book value declined to $26.65,
compared to $27.70 at the end of Q2. The firm’s Tier 1 common ratio under Basel I was 13.7% (+10 bps Q/Q): B3T1C about 9.0%+. Liquidity declined modestly to $170B, down 2 % sequentially.

On the conference call, Ruth Porat, CFO of Morgan Stanley, states:

Although calculations are not final, Tier 1 common ratio under Basel I will be approximately 13.7%, and Tier 1 capital ratio will be approximately 16.7%. Risk-weighted assets under Basel I are expected to be approximately $319 billion at September 30.

Subject to final rule making, Tier 1 common ratio under Basel III was north of 9%, as of the end of the third quarter, assuming full Basel III inflation of risk-weighted assets and zero benefit from future mitigation.

BI capital grew 10bp to 13.7%, with a likely increase in B3 too (8.5% in 2Q).

Asset Management revenues totaled $631m vs.  estimates of $478m, driven by merchant banking gains of $134m (vs. a
$3m loss here last qtr).

Issues summed up:

1) ~6% “normalized” ROE
2) Expenses grew, partly due to higher litigation expense ($280M): total expense +11% y/y (+6% y/y ex-litigation) and non-comp expense +14% y/y (+3% y/y ex-litigation), total firm headcount declined 2% q/q;
3) BV -2% q/q to $30.53 and TBV -4% to $26.65 on hit from MSSB stake buy-in (costed ~$0.58/share).
4) 45% comp ratio in ISG ex DVA
5) Asset management long-term outflows of -$5.1B.