June 20 (Bloomberg) -- Morgan Stanley, the world's No. 2 securities firm, said second-quarter profit rose 40 percent, beating analysts' highest estimates, on gains from trading stocks and bonds and fees from investment banking.
Net income climbed to $2.58 billion, or $2.45 a share, in the three months ended May 31, from $1.84 billion, or $1.75, a year earlier, the New York-based firm said today in a statement. The company's shares rose 1.7 percent.
Morgan Stanley's profit grew faster than larger rival Goldman Sachs Group Inc.'s for the second straight quarter as Chief Executive Officer John Mack overcame a slump in demand for mortgage-related securities. Fixed-income revenue at Morgan Stanley jumped 34 percent, while rising stocks fueled a 33 percent gain in equity trading.
``They really seem to have had a strong quarter across the board,'' said Mark Bronzo, who helps manage $500 million, including Morgan Stanley shares, at Nationwide Separate Accounts in Irvington, New York. ``What we were impressed by mostly is that the fixed-income trading and equity-trading numbers were better than expected.''
Morgan Stanley said revenue climbed 32 percent to $11.5 billion, an all-time high, while expenses increased 31 percent to $7.6 billion. Return on equity, a gauge of how effectively earnings are reinvested, rose to 27.5 percent from 23.7 percent a year earlier.
International Revenue
The company's profit grew faster than earnings at Goldman, Lehman Brothers Holdings Inc. and Bear Stearns, which reported results last week. Merrill Lynch & Co., the third-biggest securities firm by market value after Goldman and Morgan Stanley, releases its second-quarter figures next month. All of the firms are based in New York.
About 42 percent of Morgan Stanley's revenue came from outside the U.S. in the quarter, up from 38 percent a year earlier, David Sidwell, Morgan Stanley's chief financial officer, said in an interview. That compares with 52 percent at Goldman Sachs and 48 percent at Lehman in the second quarter.
Morgan Stanley generated $2.9 billion from fixed income, which includes mortgages, even as rising delinquencies on the riskiest home loans curbed demand for mortgage-backed bonds. Fixed-income revenue fell 24 percent at Goldman, 21 percent at Bear Stearns and 14 percent at Lehman.
``The diversification of what is in our results, that's really what has driven this strong performance,'' Sidwell said. He pointed in particular to record debt-trading income from emerging markets such as Brazil and Turkey.
Analysts' Estimates
Earnings were 25 cents a share higher than the most optimistic estimate in a survey of 18 analysts by Bloomberg. Shares of the company rose $1.52 to $89.32 at 10:21 a.m. in composite trading on the New York Stock Exchange. They gained 7.8 percent this year through yesterday, the second-best performance among the five largest U.S. securities firms after Goldman.
Morgan Stanley produced $2.2 billion in revenue from equities. The MSCI World Index of stocks rose 9 percent during the second quarter.
Average trading value-at-risk, a measure of how much the firm estimates it could lose in one day, rose to $81 million in the quarter from $63 million a year earlier. Wall Street's five largest firms are profiting from a regulatory change that's freeing up more capital for market bets.
``Their trading businesses are taking more risk, their trading businesses are becoming more Goldman-like,'' Brad Hintz, an analyst at Sanford C. Bernstein & Co. who rates Morgan Stanley shares ``market perform,'' said before the results.
Takeover Advice
Advisory revenue, which includes fees for takeover advice, almost doubled to a record $725 million, while underwriting revenue climbed 46 percent to $979 million. Morgan Stanley ended the first half of its fiscal year with $512.2 billion in completed mergers, just behind Goldman, according to data compiled by Bloomberg.
Revenue at the Discover credit-card division dropped 13 percent to $1.04 billion during the second quarter, the only division to show a decline. Mack, 62, will spin off Discover next week. The plan, originally proposed by former CEO Philip Purcell, will focus Morgan Stanley on investment banking, trading and money management, which are more profitable.
Mack followed his rivals by dedicating more capital to mortgages, including the $705 million purchase in December of Saxon Capital Inc., a home-loan servicing company.
The Mortgage Bankers Association reported last week that delinquency rates on subprime mortgages rose to 13.8 percent for the three months ended in March, up from 11.5 percent a year earlier.
Continued `Instability'
``You're going to have a continued period of instability in these markets while some of these issues get sorted through,'' Sidwell said. A recent increase in U.S. Treasury yields has increased concern about mortgage delinquencies and lowered the prices of some home loans and securities backed by them, he said.
Revenue at Morgan Stanley's brokerage unit climbed 17 percent to $1.64 billion while pretax income surged 67 percent to $269 million. The asset-management division's revenue increased 68 percent to $1.51 billion as pretax earnings increased 16 percent to $306 million.
``The brokerage and asset-management turnaround clearly has demonstrated significant traction,'' said Douglas Ciocca, who helps manage $850 million, including Morgan Stanley shares, at Renaissance Financial Corp. in Leawood, Kansas. ``I was very pleased across the board.''
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