Morgan Stanley returned to profitability for the first time in a year as income from its investment banking operations offset losses in commercial real estate.
Morgan Stanley said Wednesday that stock and debt underwriting from investment banking, and rising profits from its retail brokerage business, which includes the Morgan Stanley Smith Barney joint venture with Citigroup Inc., more than balanced out $400 million in real estate losses.
The New York-based bank earned $498 million in the July-September period, after losing $13.18 billion during the last three quarters combined.
Investors sent Morgan Stanley stock up sharply in afternoon trading, brushing off any concerns about the bank’s commercial real estate exposure. Shares jumped $2.25, or 6.9 percent, to $34.77.
Still, the commercial real estate losses are a reminder that the broader economy continues to struggle even as financial companies profit from their investment banking and trading operations. Morgan Stanley has invested more heavily in commercial real estate than some competitors like Goldman Sachs Group Inc.
The value of commercial real estate has tumbled in many parts of the country as many small companies shut down due to the recession, leaving a growing amount of office building and shopping center space empty. Moreover, commercial real estate rents are falling, cutting into the income landlords get from their properties.
Colm Kelleher, Morgan Stanley’s chief financial officer, said the commercial real estate business will continue to be a drag on earnings into 2010, as the sector usually is one of the last to bounce back during an economic recovery.
Phillip Silitschanu, a senior analyst at research firm Aite Group, said all companies with exposure to the commercial real estate market are likely to face troubles for the next six months to a year.
Kelleher did note that because of aggressive write-downs and reduction in exposure to the market in past quarters, commercial real estate-related charges will continue to shrink in future quarters. Real estate charges totaled $700 million in the second quarter.
Like Goldman Sachs and JPMorgan Chase & Co., Morgan Stanley used a rebound on Wall Street to bolster its bottom line during the third quarter. Revenue from managing other companies’ stock offerings more than doubled in the quarter to $457 million, while revenue from underwriting debt offers jumped 25 percent to $303 million.
Morgan Stanley is also reaping benefits from the expansion of its retail brokerage business. The bank acquired a majority stake in Smith Barney from Citigroup in May, and merged the operations with its own wealth management division. The combined operations helped Morgan nearly double its revenue to $3.03 billion in that division.
Kelleher said integration expenses and the merging of operations have kept the bank from tapping into the full earnings potential of the retail brokerage division. Morgan Stanley’s profit margin could more than double to around 25 percent in 2010 at Morgan Stanley Smith Barney, he said.
It is widely expected the bank will exercise its eventual option to purchase Citigroup’s 49 percent stake in the venture.
Morgan Stanley had gains in both trading and investing in the third quarter as well. The bank was criticized for remaining too conservative during the second quarter as a market rebound started in March and helped competitor Goldman post a staggering profit. Morgan Stanley’s cautiousness hindered its ability to offset real estate and other losses in the second quarter.
Revenue from third-quarter principal trading and investments accounted for 39 percent of Morgan Stanley’s total revenue, up from 34 percent in the second quarter, as it began ramping up its trading business again. However, that was far behind Goldman, which generated more than 80 percent of its third-quarter revenue from principal trading and investments.
Morgan Stanley is further ramping up its trading desks as it looks to build that business, including hiring more traders, Kelleher said. He said it’s one of the divisions that has the most room for growth.
The bank, however, won’t expand at the expense of the stronger risk management in place since the credit crisis peaked last year.
“It’s very important that we are not seen as irresponsible risk takers,” Kelleher said during an interview with The Associated Press.
Within trading, Morgan Stanley focused on the debt market. Revenue from fixed income trading more than doubled from the previous quarter and was almost twice as large as revenue from equities trading.
Cubillas Ding, a senior analyst at financial consulting firm Celent, said Morgan Stanley has made a clear move to focus on specific businesses where it is the most competitive.
“There has been a narrowing of what businesses they choose to play in, but they have strategically chosen to focus on activities they have an advantage in, and to sidestep businesses that are subscale in nature,” Ding said.
Morgan Stanley’s third-quarter profit applicable to common shareholders totaled $498 million, or 38 cents per share. Analysts polled by Thomson Reuters, on average, were expecting earnings of 27 cents per share.
Morgan Stanley’s quarterly results were hurt for a third straight quarter by an accounting charge related to the rising value of its own debt. The bank took a $900 million charge to reflect the greater cost it would incur to repurchase its outstanding debt, which is worth more now because of the bank’s improving financial condition.
That same accounting rule allowed Morgan Stanley to book a $9.7 billion gain during the third quarter last year as its debt plummeted in value amid fears it might collapse, as its competitor Lehman Brothers did.
Revenue totaled $8.68 billion in the third quarter, easily topping analysts’ forecast for $7 billion. Morgan Stanley generated $18.01 billion in revenue during the same period last year, which was skewed by the $9.7 billion accounting adjustment.
Copyright 2009 The Associated Press.