Morgan Stanley: Financial Winner, Again

NEW YORK ( TheStreet) -- Morgan Stanley ( MS) was again the winner among the largest U.S. financial names on Wednesday, with shares rising over 1% to close at $15.68.

The broad indexes ended mixed, ahead of Thursday's European Central Bank (ECB) policy meeting, with Bloomberg reporting that ECB President Mario Draghi will propose "unlimited purchases" of government bonds, while refraining from "setting a public cap on yields," according to unnamed sources.

The KBW Bank Index ( I:BKX) pulled back slightly to close at 47.13, with 14 of the 24 index components showing declines for the session.

Looking ahead to the next earnings season for the financial services industry, Credit Suisse analyst Moshe Orenbuch on Wednesday said he expected that "mortgage banking revenue will continue to be solid in 3Q, benefiting from a higher than average gain on sale margins and continued strong origination activity," leading his firm to increase its "mortgage forecasts for our banks under coverage to up 9% q/q in 3Q (from previous estimates of down 15% q/q)."

The Mortgage Bankers Association estimates that total third-quarter originations will total $$371 million, which is roughly flat from the second quarter. Most newly originated mortgages are quickly sold to Fannie Mae ( FNMA) or Freddie Mac ( FMCC), and Orenbuch estimates that the average gain-on-sale margin for lenders "be 3.24%, on average, based on the spreads between primary and secondary rates versus 3.08% in 2Q'12."

The analyst said that "third-quarter spreads are expected to be well in excess of the 9-qtr average of 2.05% given reduced industry capacity and the elevated profitability of the HARP 2.0 program-which should support healthy production revenues this quarter." HARP is the Home Affordable Refinance Program, which President Obama expanded early this year, to allow qualified borrowers with mortgages held by Fannie of Freddie to refinance their entire loan balance, at today's low rates, no matter how far "underwater" the underlying property might be, following the collapse of housing values.

Under HARP 2.0, there is no loan-to-value ratio limit, where a lender originating a traditional first-lien mortgage loan would typically require the borrower to obtain costly private mortgage insurance, to protect the lender, if the loan is for more than 80% of the underlying home's market value.

Credit Suisse has a mixed outlook for the third quarter, for investment banks. Analyst Howard Chen on Wednesday said that "global capital markets conditions had a fair August - risky asset prices broadly continue to hold in, fixed income market conditions remain resilient thanks in part to continued healthy tone to the credit markets and client positioning ahead of central bank actions (both here and abroad) and we did see glimpses of new M&A deal announcements in what is traditionally a very quiet season."

Still, Chen said that third-quarter "investment banking activity has been a mixed bag," and that "M&A has been overall weak--completed M&A is down 12% qtr/qtr; announced M&A is down 9% qtr/qtr."

Trading revenue remains pressured, as "calendar third quarter-to-date, global exchange volumes are lower from both year-ago and second quarter levels," and Chen expects "an 8% decrease in retail trading activity during the third quarter relative to the second quarter driven by continued uncertain market conditions and weak retail trading environment."

Morgan Stanley is among Chen's "top picks for the next twelve months," along with Goldman Sachs ( GS), Blackstone ( BX), Apollo Global Management ( APO), Carlyle Group ( CG), Lazard ( LAZ), CME Group ( CME) and Intercontinental Exchange ( ICE).

Chen's price target for Morgan Stanley is $22, and the analyst estimates the company will earn 25 cents a share for 2012, followed by EPS of $2.05 in 2013.

CLSA analyst Mike Mayo on Tuesday upgraded Morgan Stanley to a "Buy" rating from an "Outperform" rating, while raising his price target for the shares to $23 from $16, saying that "since six weeks ago when we began recommending the stock for the first time since the financial crisis, after the dismal 2Q12 results, we are further convinced that either management realizes more of the franchise value or investors will increasingly pressure management for improved results."

Mayo said "we see a consensus among investors for more aggressive restructuring" of Morgan Stanley's trading operations, adding that "the stock is priced near a crisis-low valuation of 0.5x tangible book value vs 0.3x during the crisis period, despite a much lower risk profile," and that "our sum-of-the-parts analysis shows the firm is worth $16-32/share."

May estimates that Morgan Stanley will earn 90 cents a share for 2012, followed by earnings of $1.90 a share in 2013.

Morgan Stanley currently holds 51% of the Morgan Stanley Smith Barney Joint Venture, with Citigroup ( C) holding the remaining 49%. Morgan Stanley has the option to purchase the remaining stake in the joint venture over a three year period beginning this year, and in May announced plans to purchase an additional 14% stake, subject to a valuation that will be determined by Perella Weinberg Partners LP, with an extended deadline of Sept. 10.

The formation of the joint venture benefited Citigroup immensely during the second quarter of 2009, when the company sold its Smith Barney subsidiary to the joint venture and booked a gain of $11.1 billion, shoring up its capital, while the company was still suffering tremendous credit losses.

Analysts are expecting Citigroup and Morgan Stanley to compromise on the joint venture's valuation, leading to a third-quarter write-down for Citi, likely ranging between $3 billion and $4 billion.

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-- Written by Philip van Doorn in Jupiter, Fla.

>Contact by Email.

Philip W. van Doorn is a member of TheStreet's banking and finance team, commenting on industry and regulatory trends. He previously served as the senior analyst for TheStreet.com Ratings, responsible for assigning financial strength ratings to banks and savings and loan institutions. Mr. van Doorn previously served as a loan operations officer at Riverside National Bank in Fort Pierce, Fla., and as a credit analyst at the Federal Home Loan Bank of New York, where he monitored banks in New York, New Jersey and Puerto Rico. Mr. van Doorn has additional experience in the mutual fund and computer software industries. He holds a bachelor of science in business administration from Long Island University.

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