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Morgan Stanley's


fourth-quarter earnings report had investors smarting, but the pain might have been worse if the company had been more conservative in some of its accounting decisions.

The best-performing division at Morgan Stanley in the last quarter was its Discover credit card business, which posted $194 million in net income, a 1% gain over last year.

But a good deal of Discover's performance is due to a potentially risky decision by Morgan Stanley to set aside less money in a quarterly reserve account to cover defaults by consumers on their credit card bills. And that's a move that could come back to haunt the brokerage if the economy worsens and Discover borrowers can't pay their bills.

Indeed, some financial analysts say that given the uncertain economic climate, now is not the time for Morgan Stanley to be lowering its reserves. But they say the nation's second-largest brokerage may be taking that gamble to offset the weak earnings reported by its retail brokerage and investment banking divisions.

"It's somewhat surprising," said Sean Eagan, president of Egan-Jones Ratings, a small corporate credit rating agency. "It's contrary to the experience of other players in the

credit card industry. A high level of skepticism is needed."

In the fourth quarter, Morgan Stanley set aside $319 million for credit card loan losses, 4% less than in the third quarter and 3% less than the year-ago period.

Now a sequential reduction of 4%, or $13 million, may not sound like much, but every dollar a credit card lender doesn't put into this particular account goes toward fattening its bottom line. And this quarter, Morgan Stanley clearly needed all the help it could get in presenting the best face to investors.

Overall, the brokerage reported net earnings of $732 million, or 67 cents a share, a figure that includes a $235 million restructuring charge due to job cuts and real estate losses. On an operating basis, the firm reported earnings of 81 cents a share, a number that exceeded the 75-cent consensus estimate of most Wall Street analysts.

David Hendler, a financial services analyst with CreditSights, an independent credit rating service, estimates that Morgan Stanley may have added a few pennies to its earnings by reducing its credit card reserves in the quarter.

"They were aggressive," said Hendler. "There is an overall need to generate earnings."

Morgan Stanley officials, meanwhile, defended the move by noting that the percentage of Discover customers who've fallen behind on paying their credit card bills was down in the fourth quarter from a year ago. They say the downward adjustment in the amount of money set aside for loan losses in the quarter is justified. The so-called delinquency rate for customers with bills overdue by 90 days declined to 2.66% from 3.02% a year ago. And overall, the firm points out that the total reserves on its balance sheet for credit-card losses remained unchanged from the third quarter, despite the decline in the quarterly provision for loan losses.

That's the good news.

The bad news is that the charge-off rate for bad consumer debts rose during the same period and is now running at 5.96%, up from 5.85% a year ago. That means Morgan Stanley, in the fourth quarter, had to write down a higher percentage of credit card debt as uncollectable, compared with a year ago.

Now, some financial observers will say the downward direction in the delinquency rate is more important than the charge-off rate because it's a predictor of future defaults. And if fewer Discover customers are falling behind on paying their bills, that means there will be fewer actual defaults in the future.

But Eagan notes that some credit card firms have a funny habit of adopting a more rigid interpretation of what constitutes a delinquent account when the economy worsens. Morgan Stanley, he notes, probably won't have to provide that kind of information until it files its 2002 annual report early next year.

Its investors now must hope the report doesn't include any unpleasant discoveries about the firm's Discover business.