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Morgan Stanley Must Move Past Facebook, Downgrade

NEW YORK ( TheStreet) - After reporting the biggest bank earnings beat in the first quarter, Morgan Stanley (MS - Get Report) is again an outlier on Wall Street as investors brace for its second quarter results, due on Thursday morning.

In a quarter marked by fast-falling earnings expectations and a multi-billion dollar trading loss at JPMorgan (JPM - Get Report), Morgan Stanley encountered among the sector's biggest challenges as an underwriting mandate for Facebook's (FB - Get Report) initial public offering fell flat and the bank faced the sharpest cuts in a sector-wide ratings downgrade by Moody's.

Now, second quarter results will help to show whether Morgan Stanley is strategically positioned to compete with larger universal banks - potentially putting a floor to battered share prices -- or whether its discount is warranted.

Morgan Stanley's earnings will reveal the impact of Moody's two notch ratings downgrade on its trading operations compared to peers like Goldman Sachs (GS - Get Report) and JPMorgan, who have a stronger toehold in key trading businesses. Meanwhile, earnings will also show any fallout from Morgan Stanley's botched Facebook IPO effort, which was hindered by aggressive pricing and flawed execution on the part of Nasdaq (NDAQ).

"Earlier this year, Morgan Stanley won Wall Street bragging rights for leading the long awaited Facebook IPO. In making their pitch to Facebook, Morgan Stanley bankers promoted their firm's ability to distribute Facebook stock through its retail brokerage distribution channel. But blunders in the pricing process of the new issue have pulled defeat from the jaws of victory in a very public manner," wrote Bernstein Research analyst Brad Hintz, in a May note assessing the fallout of Facebook's botched IPO.

Execution will be on the minds of many as chief executive James Gorman continues to work to prove that he can deliver on Morgan Stanley's retreat from some principal trading businesses and its full force push into wealth management.

"The Morgan Stanley story has been an execution story for a long time," says Morningstar analyst Michael Wong, citing the company's push into brokerage and wealth management operations through its Morgan Stanley Smith Barney joint venture with Citigroup (C - Get Report).

In late May, Morgan Stanley alerted Citigroup of its intent to exercise a right to purchase an additional 14% stake in the joint venture, beginning a multi-year schedule where it can build full ownership of the unit created in 2009, from a present 51% stake. In Monday earnings, Citigroup Chief Executive Vikram Pandit said that both parties within 10% on negotiating the value of the 14% stake up for grabs.

"I will be concentrating on where operating margins are going," adds Wong, who notes that Morgan Stanley and its CEO Gorman have so far been slow to realize expense synergies and an expected increase in the unit's profit margins over time. Currently the Morgan Stanley's 10% brokerage margins are roughly half of what the bank projected when first entering the joint venture.

With a brokerage unit that now is among the largest in the world, Morgan Stanley is hoping to move from capital intensive trading and proprietary investment operations into low capital and low risk businesses like wealth management, which may bolster the bank's liquidity and its return on equity, as new regulations like Basel III and the Dodd Frank Act kick in.

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