Updated from 12:24 p.m. EST

Morgan Stanley's

(MWD)

fourth-quarter earnings fell 28% from a year ago as the recession and terrorist attacks took their toll on its brokerage operation. But the second-largest U.S. securities firm cautiously painted an improved picture for next year.

"While there's not a lot of objective data to suggest this, we feel that trends have bottomed and we're probably going to move up from here," chief financial officer Steve Crawford said in a conference call with reporters. "That will probably show up more in second half in terms of actual revenue contribution, but it feels like there's more stability and health in the markets than there was three months ago."

The investment bank said fourth-quarter earnings were $870 million, or 78 cents a share, compared with earnings of $1.21 billion, or $1.06 a share, in the same period last year.

Its numbers sharply exceeded analysts' expectations of 66 cents a share, as compensation costs, which are determined largely by revenue levels, fell significantly.

"We have focused on reducing expenses throughout 2001 and we will continue this effort in 2002," Morgan Stanley said in its prepared statement. The company said its total headcount was reduced by 1,000 to 61,319 during the fourth quarter.

Meanwhile, fourth-quarter revenue fell 17% to $4.6 billion, from $5.5 billion last year, reflecting substantially lower levels of activity in almost all institutional and individual investor businesses. But the company said better results from trading in government debt and interest rate derivatives drove its fixed-income revenue.

Morgan Stanley's shares were recently gaining $2.13, or 4%, to $55.70. The stock has risen 29% since the market hit its lows on Sept. 21, but is sharply off its 52-week high of $90.49.

Revenue Down

The brokerage business has suffered this year as a result of the U.S. recession. Soft markets have also dissuaded companies from

issuing stock and

making deals.

Advisory revenue fell 44% to $319 million in the fourth quarter, due mainly to the sharp decrease of global mergers and acquisitions activity that began during the second half of last year. "One could anticipate that the first half of next year could be more difficult than the second half of this year," Crawford told reporters. But "anecdotally, we feel better in terms of things having bottomed and trended upward in terms of announced activity today than we have for some period of time," he added.

Underwriting revenue slipped 12% to $479 million due to a 50% decline in global stock issuance volume. "I don't think there's been a dramatic change in the IPO pipeline or that expectations that will increase dramatically near-term," Crawford said.

Crawford also said the most significant impact from the Sept. 11 terrorist attacks was reflected this quarter. But he added that it would be a "long and complicated process" estimating all costs, and they could show up in future results.

Credit Quality

Morgan Stanley, which owns the Discover Credit Card, also said it expects higher charge-off levels in its credit card business next year due to worsening credit quality, though Crawford said the forecast was "very speculative."

Despite worsening credit card losses, fourth-quarter credit services income rose 31% to $193 million from the same period last year, fueled by higher net interest income and lower marketing and business development expenses.

"Morgan Stanley has seen some increases in their charge-offs versus last year, and delinquencies are also up a little bit, but I don't see how what they're experiencing is really different from the trends we're seeing in the industry," said Kathy Shanley, an independent corporate bond analyst at Gimme Credit, pointing out that the company's charge-offs were better than the industry average.

"Also, Discover has the added benefit as historically it hasn't been accepted as quite as many outlets as some other credit cards," Shanley said. "But certainly this is a challenging time for anyone in the consumer lending business."