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Morgan Stanley (MS - Analyst Report) reported impressive second-quarter 2013 earnings, with a positive surprise of about 5%. Adjusted earnings from continuing operations of 45 cents per share beat the Zacks Consensus Estimate of 43 cents. Moreover, this compares favorably with 16 cents earned in the prior-year quarter.

Better-than-expected results were driven by growth in revenues, partly offset by higher expenses. Moreover, an increase in net revenue across all segments was the tailwind. Further, improved asset position and stable capital ratios were the other highlights.

Including debt-related credit spreads, Debt Valuation Adjustment (DVA) and negative adjustment related to purchase of the remaining interest in Morgan Stanley Wealth Management (MSWM) joint venture (JV), net income from continuing operations was $1.0 billion or 43 cents per share. This compares favorably with net income of $562 million or 28 cents per share in the year-ago quarter.

Further, in the second quarter, Morgan Stanley ranked #2 in global announced M&A and global IPOs.

Behind the Headlines

Net revenue (excluding DVA adjustments) for the quarter was $8.3 billion, up 26% from the year-ago quarter. Moreover, net revenue outpaced the Zacks Consensus Estimate of $8.0 billion. After taking into consideration the negative revenues pertaining to changes in Morgan Stanley’s debt-related credit spreads and DVA, net revenue grew 22% year over year to $8.5 billion.

Morgan Stanley recorded net interest income of $204 million in the reported quarter, compared with a negative net interest income of $160 million in the year-ago quarter. The year-over-year improvement primarily stemmed from an 18% fall in interest expenses.

Total non-interest revenues jumped 17% year over year to $8.3 billion. All the non-interest income components grew from the prior-year quarter.

Total non-interest expenses were $6.7 billion, up 12% from the previous-year quarter. Morgan Stanley’s compensation to net revenue ratio for the reported quarter was 48%, compared with 52% in the year-ago quarter.

Segment Performance

Institutional Securities (IS) reported pre-tax income from continuing operations of $960 million, surging 97% from the prior-year quarter. Net revenue was $4.3 billion, up 30% from $3.3 billion in the year-ago quarter. Further, excluding DVA, net revenue was $4.2 billion, rising 40% on a year-over-year basis.

Global Wealth Management (GWM) pre-tax income from continuing operations was $655 million, increasing 60% from the year-ago quarter. Net revenue was $3.5 billion, improving 10% from $3.2 billion in the year-ago quarter, reflecting higher asset management fees and transactional revenues.

Asset Management (AM) pre-tax income from continuing operations was $160 million, up significantly from 43 million in the year-ago quarter. Net revenue for the reported quarter was $673 million, up 48% from $456 million in the year-ago quarter. The rise was driven by robust results in the Traditional Asset Management business, along with gains on investments in the Merchant Banking business.

As of Jun 30, 2013, total assets under management or supervision were $347 billion, up 12% from $311 billion as of Jun 30, 2012. The rise primarily reflected positive net customer flows and market appreciation.

Capital Ratios

As of Jun 30, 2013, book value per share was $31.48, up from $31.02 as of Jun 30, 2012. Tangible book value per share was $26.27, down from $27.70 as of Jun 30, 2012.

Morgan Stanley’s Tier 1 capital ratio, under Basel I, was 14.1% and Tier 1 common ratio was 11.8% compared with 17.2% and 13.6%, respectively in the year-ago quarter.

Capital Deployment Actions

Along with the earnings release, Morgan Stanley declared a quarterly dividend of 5 cents per share. The dividend will be paid on Aug 15 to shareholders of record as of Jul 31.

Further, Morgan Stanley received no objection from the Federal Reserve to buy back shares. The company has authorized repurchase of shares worth up to $500 million through Mar 31, 2014.

Performance of Other Major Banks

Among other Wall Street biggies, JPMorgan Chase & Co. ((JPM - Analyst Report)), Citigroup Inc. (C - Analyst Report) and Bank of America Corporation (BAC - Analyst Report) have reported better-than-expected second-quarter results and upheld the banking image.

Banks have been reporting strong results, primarily on the back of favorable macroeconomic elements. Top-line growth, expense management and lower provision were the primary driving factors.

Our Viewpoint

Morgan Stanley’s initiatives to offload its non-core assets for reducing balance sheet risks and shifting focus on the less capital incentive AM and GWM segments are commendable. Further, in Jun 2013, the company purchased the remaining 35% stake in MSWM JV from Citigroup. The company paid $4.7 billion in cash, as per the agreement in Sep 2012. This stake buy will diversify Morgan Stanley’s revenue base and stabilize its earnings going forward.

Additionally, the approval of Morgan Stanley’s share repurchase plan reinforces the belief that its capital position is stable. Moreover, there are high chances of enhanced dividend payments going forward, provided it receives the Fed’s consent for the same.

Moreover, Morgan Stanley’s organic and inorganic growth initiatives continue to be significant growth drivers. The company remains focused on diversifying its revenue base by expanding its footprint in economies that are less impacted by the financial crisis and the European debt crisis.

However, there are concerns related to Morgan Stanley’s financials being marred by new regulatory requirements and intense pricing competition. Moreover, stringent capital norms may somewhat lower the company’s flexibility with respect to its investments and lending volumes.

An investor with the ability to absorb risks related to market volatility should not be disappointed with investments in Morgan Stanley in the long run. The company’s fundamentals remain highly promising with a diverse business model and a stable balance sheet and capital position.

Morgan Stanley currently carries a Zacks Rank #3 (Hold).

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