This summary is based on the third quarter fiscal 2007 earnings call conducted by Morgan Stanley (MS) on September 19, 2007.
EVP, Exiting CFO: David Sidwell
Head, Global Capital Markets, Incoming CFO: Colm Kelleher
Key Investors Issues
- EPS from continuing operations were $1.38 a share compared to $1.50 a share last year.
- Income from continuing operations fell to $1.47 billion from $1.59 billion a year earlier.
- Net revenue rose 13% to $8 billion from last year.
Second Quarter Highlights
Income from continuing operations was $1.5 billion, down from record last quarter of $2.4 billion.
- Earnings per share from continuing operations were $1.38 per share, versus a record $2.24 a share last quarter.
- Return on equity from continuing operations was 17.2%, down from 29%.
- Results for Discover for all periods have been reclassified to discontinued operations, including the one-month results for June in the current quarter.
- Earnings per share were $1.44 a share, compared with $2.45 last quarter.
- Net revenues were $8 billion, 24% lower than quarterly record in the second quarter, driven by the decrease in institutional securities revenues.
The credit markets deteriorated considerably over the course of the quarter, with increased volatility, spread widening, lower levels of liquidity and reduced price transparency at all parts of the capital structure.
These factors affected the leveraged lending markets, the effectiveness of hedging strategies, sub-prime mortgage markets including the CDO market, as well as other structured credit products. This credit environment impacted results in relationship and leveraged lending, and credit sales and trading.
In relationship and leveraged lending, where markdowns to loans and commitments led to losses of approximately $940 million reported in other sales and trading net revenues. The earnings per share impact from these losses were approximately 33 cents a share. These losses include the $726 million impact of marking to market including certain fees a $31 billion pipeline of leveraged loan commitments made to support acquisitions made by financial sponsors.
Corporate credit and securitized credit product sales and trading businesses, including residential and commercial mortgage businesses, had lower revenues than the strong second quarter.
- Revenues were approximately $260 million, compared with $1.3 billion last quarter, with the largest decrease in corporate credit where losses in structured credit business, as the extreme market moves impaired the performance of hedge strategies, more than offset strong investment grade and other trading results.
- Residential and commercial mortgage business had lower revenues than the second quarter as the market continued to deteriorate, particularly in the senior portion of the capital structure.
- The company reduced positions in light of the market continues in corporate, residential, and commercial credit.
- Quantitative strategies had losses of approximately $480 million.
The credit environment impact on lending and credit sales and trading was partially offset by an approximately $390 million gain from the spread widening in Morgan Stanley''s credit on some of own structured notes.
- Of this amount, approximately $290 million was reported in fixed income sales and trading and $100 million in equity sales and trading.
- The turn in the environment coming on the heels of strongest quarter ever exacerbated the steepness of the sequential quarterly decline. However, the diversity of platform enabled to generate a solid, firm-wide 17.2% return on equity.
- Institutional securities were strong in investment banking.
- Equities business produced strong results, excluding quantitative strategies.
- The company had record interest rate and currency trading and prime brokerage results.
- Commodities had a solid quarter.
- The company continued to demonstrate progress in improving global wealth management and active management results. All of these businesses mitigated the impact the significant market disruption had on overall results.
While revenues decreased 24% from the second quarter, total non-interest expenses were $5.7 billion, down 19%.
- The largest component, compensation benefits expense, was $3.6 billion, down sequentially from $5 billion primarily reflecting the low revenues, as well as adjustments to the full year estimated payout to reflect revenue trends and outlook for institutional securities and asset management.
- Non-compensation expense was $2.1 billion, up 4.5%, driven by higher brokerage and clearing reflecting an unprecedented volume of trade.
- The non-compensation to net revenue ratio was 26%.
- Effective income tax rate for continuing operations increased from the second quarter by 1.8 percentage points to 34.4%. This was primarily due to lower estimated tax credits due to the higher anticipated phase out of coal credits.
- The company produced a healthy 17.2% return on equity, despite the material dislocation in the credit markets.
Segment Performance
Institutional Securities Segment
The market conditions drove the segment''s revenues lower in equity and fixed income sales and trading, as well as investment banking.
- Net revenues of $5 billion were down 33% from the second quarter of 2007.
- Non-interest expenses of $3.5 billion decreased 22%, driven by lower compensation in light of the lower revenues.
- PBT of $1.5 billion was down 49% from last quarter''s record, and the profit before tax margin of 30%, was down from the 40% reported last quarter.
- Return on equity was 16%, down from 35%.
