Big Number at Morgan Stanley

Earnings rise 17%, trouncing analysts' estimates.
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Updated from 9:41 a.m. EST

Morgan Stanley

(MS) - Get Report

became the fourth Wall Street brokerage in eight days to overshoot analysts' forecasts Wednesday, posting a 17% rise in first-quarter net income that reflected record sales and trading, particularly in fixed-income products.

Morgan Stanley earned $1.64 billion, or $1.54 a share, in the quarter, compared with $1.40 billion, or $1.29 a share, a year ago. Analysts surveyed by Thomson First Call were forecasting $1.21 a share in the latest period.

Revenue for the quarter was $8.483 billion, beating estimates of $7.553 billion.

In Morgan's biggest unit, institutional securities, revenue rose 36% from a year ago, reflecting a 66% increase in trading and a 20% rise in investment banking revenue. The company's second-largest group, global wealth management, saw revenue rise 4% from last year.

"Given what we heard from their peers, we figured it was going to be a good quarter," said Jeffery Harte, analyst at Sandler O'Neill & Partners. "Investors tend not to like trading revenues, but they are starting to open their eyes to this being a real business."

Risk Measures

Like competitor

Goldman Sachs

(GS) - Get Report

, Morgan Stanley benefited from heavy trading in fixed-income markets, and saw record revenue in commodities such as natural gas and oil liquids.

Unlike Goldman, however, the company didn't take on quite as much risk as last year. The "value at risk" metric, which is supposed to represent the amount of money a trading operation could lose in one day if all its bets went south, fell to $84 million in the quarter vs. $96 million the same period a year ago. The VAR measure was slightly higher than $81 million in the fourth quarter last year.

On the earnings call, Chief Financial Officer David Sidwell said the company will look to increase its trading risk as necessary, but will vary the risk accordingly within the separate markets.

Morgan Stanley is in the process of reinventing itself under new leadership after months of upheaval and high-profile departures at the firm. The biggest change saw the return to the firm of John Mack, who was named CEO last year after Phil Purcell's departure.

"We are directing resources, capital and people to areas in the institutional securities businesses where we see the most attractive opportunities, such as emerging markets, leveraged finance, derivatives, principal investments and mortgages," Mack said. "In our retail and asset management businesses, we are making the necessary changes and investments to fully leverage those franchises."

Mack also said that some of the changes made in the past quarter will take time to translate into earnings. "We still have a great deal of work to do, and the results of these efforts will not flow to the bottom line all at once. But we are making progress and we remain intensely focused on improving our growth, profitability and return on equity."

Morgan Stanley has restructured almost every unit since Mack's arrival. This quarter, the company made numerous strategic hires in investment banking and in its sales and trading divisions, particularly in debt origination and trading.

The company also added James Gorman from

Merrill Lynch

(MER)

to head its global wealth management group. Since Gorman's arrival, he has reorganized the segment's top management positions and hired some of his former colleagues from Merrill.

Sound Decisions

After arriving last year, Mack made a decision to keep Morgan Stanley's Discover credit-card division in order to shield the firm from too much securities exposure. Under Purcell, Morgan Stanley had contemplated spinning off the credit-card unit. This quarter, the decision proved to be a good one, with revenue in its third-largest group increasing 14%.

One area in which Morgan Stanley hasn't had the same success is the asset-management group, though it isn't from a lack of trying. In late January, the company was rumored to be looking at buying bond fund manager

BlackRock

(BLK) - Get Report

. However, the next month BlackRock struck a deal to merge with Merrill Lynch's mutual fund division.

According to reports at the time, Morgan Stanley's talks with BlackRock dissipated over price. But many analysts speculated that management at Morgan Stanley couldn't stomach relinquishing control of the asset-management group, something that Merrill Lynch has done in its deal with BlackRock.

In the first quarter, the asset-management division was the only segment that didn't have large gains. Revenue was flat year-over-year, and assets under management were up only 4% from the previous year, with retail assets declining by $6 billion from a year ago.

Sandler O'Neill's Harte says that the asset management business is "a work in progress", but the fundamentals show that the business can grow. "The thing that you really need to watch is the asset levels and the revenue coming from those assets," he says. "Both are going in the right direction."

Meanwhile, Morgan's Sidwell said that the company believed asset management was a great business and one to which the firm is tremendously committed. He said the company will add individuals, small teams and make small acquisitions to help build out the high-margin and fast-growing alternative-investments business.