The investment bank released a typically messy earnings report, springing in part from debit valuation adjustments (DVA), which along with credit valuation adjustments (CVA), never should have been adopted by large banks in the first place. These are accounting adjustments made so that changes in the valuations of banks' own outstanding bonds flow through to the balance sheet, with a negative effect on earnings if the bond valuations go up, on the basis of potentially higher borrowing costs. There's a positive effect on earnings when bond valuations decline.
All things being equal, this means that as long-term interest rates rise, banks book extra losses, and vice versa.
Morgan Stanley reported fourth-quarter operating earnings applicable to common shareholders of $133 million, or seven cents a share, compared to $880 million, or 45 cents a share, during the third quarter, and $568 million, or 29 cents a share, during the fourth quarter of 2012.
Excluding DVA, Morgan Stanley's income from continuing operations came to $433 million, or 20 cents a share, on net revenue of $8.198 billion, compared to earnings from continuing operations of $982 million, or 49 cents a share, on net revenue of $7.474 billion, a year earlier. The results for the fourth quarter of 2013 included extraordinary legal expenses of $1.4 billion, or 40 cents a share. The fourth-quarter results also included a tax benefit of $192 million, or 10 cents a share.
Investors were clearly pleased with the revenue growth, and Oppenheimer analyst Chris Kotowski in a note to clients estimated that the investment bank's core earnings "with a normal tax rate" were roughly 48 cents a share, above the consensus EPS estimate of 45 cents, among analysts polled by Bloomberg.
JPMorgan Chase analyst Kian Abouhossein's estimate for Morgan Stanley's core earnings was even higher: "Using a normalized tax rate we get to clean EPS c50," he wrote in a note to clients. "All divisions were better than expectations, with Investment Management particularly strong," he added. Abouhossein rates Morgan Stanley "overweight," with a price target of $32.00.
Atlantic Equities analyst Richard State has a differing view of Morgan Stanley, rating the stock "underweight," with a price target of $27.00. He pegged Morgan Stanley's core earnings for the fourth quarter at 47 cents a share. "The bank is bringing forward its [fixed income trading, or] FICC risk reduction targets to 2015 from 2016. It is also setting a new expense ratio target of 79% for 2014 and beyond with the aim of raising the [return on tangible common equity] ROTCE to 10% to 11%+. Given the continued weak performance of FICC we remain sceptical that MS will achieve even this relatively low financial target," Staite wrote in a client note.
The broad indices ended mixed on Friday, while the KBW Bank Index was down 0.3% to 70.31, with winners and losers roughly split. Big banks with stocks making large moves on Friday included Bank of New York Mellon (BK), which was down 3.5% to 32.73, and SunTrust (STI), which was up 3.6% to close at $39.37. Please see TheStreet's earings coverage for details on fourth-quarter results for BNY Mellon and SunTrust.
Capital One (COF) was the loser among large-cap banks on Friday, with shares sinking 5.2% to $72.48. The company following Thursday's market close reported fourth-quarter earnings available to common shareholders of $859 million, or $1.45 a share, down from $1.099 billion, or $1.86 a share, the previous quarter, but up from $825 million, or $1.41 a share, a year earlier.
Fourth-quarter EPS came in well below the consensus estimate of $1.57.
A major factor in the sequential earnings decline was an increase in marketing expenses to $427 million in the fourth quarter from $299 million the previous quarter and $393 million a year earlier, as the company
One positive development for Capital One was that it began growing loan balances again during the fourth quarter. Average domestic credit card loans rose 1% during the quarter, to $70.368 billion, although they were down 13% from a year earlier, as the company wound-down the riskier part of the U.S. credit card portfolio it purchased during 2012 from HSBC (HSBC), while in September completing the sale of its $6 billion portfolio of Best Buy (BBY) credit card accounts to Citigroup (C).
In a note to clients late on Thursday, KBW analyst Sanjay Sakhrani wrote that "unlike many of its peers in the banking industry, COF is investing for growth and hopefully this manifests into loan growth in 2H14 and revenues in 2015. We believe management also has the flexibility to pull back on marketing spend and/or operating expenses to the extent that the operating environment proves to be more challenging."
Sakhrani rates Capital One "outperform," with an $88 price target, and wrote that "to the extent there is considerable weakness we'd be buyers of the shares." He also likes the company's "solid capital position," along with "the likelihood of a step up in the company's payout ratio, its ability to generate strong returns, along with leverage to an improving US economy and rising interest rate environment."
Capital One shares are indeed trading on the cheap, compared to most other large-cap banks, while the company's third-quarter return on average tangible equity was a decent 13.81%.
The shares trade for 9.9 times the consensus 2015 EPS estimate of $7.35, among analysts polled by Thomson Reuters. The consensus 2014 EPS estimate is $6.87. The company earned $6.96 a share during 2013.
This chart shows the performance of Capital One's stock against the KBW Bank Indexand the S&P 500
data by YCharts
-- Written by Philip van Doorn in Jupiter, Fla.