Strong earnings and 'game changer' deal give Morgan Stanley a boost

NEW YORK — Morgan Stanley is feeling good about its future.

The New York bank said Thursday that it will buy back up to $500 million of its own shares, news that surprised investors and helped boost the share price by more that 4 percent. It also reported higher earnings and revenue for the second quarter, helped by gains in both its investment bank and wealth management. And it's fresh off closing its purchase of brokerage firm Smith Barney from Citigroup, a yearslong process that has been central to CEO James Gorman's plan to reshape Morgan Stanley. In a call with analysts, Gorman called the purchase "a game changer" and promised it would benefit the bank "now and for decades to come."

"We've been on a long journey to generate stronger, more sustainable long-term returns with businesses that balance each other in volatile markets," Gorman said. That business model, he added, is now "solidly in place."

Gorman, Australia-born and a lawyer in his early career, came to the helm of Morgan Stanley at the start of 2010, when memories of the bank stumbling through the financial crisis were fresh. The CEO, who turned 55 this week, spent the early quarters embarking on expensive cleanup measures, including settling a big lawsuit with insurance company MBIA.

He has also focused on pumping up wealth management; the purchase of Smith Barney is something he started stitching together when he was still Morgan's Stanley's co-president. That deal was kindled in 2009; Gorman thought Morgan Stanley needed to expand its reliance on the steadier revenue of helping people manage their money, rather than the significant gains — and significant losses — that can come with riskier investment banking activities.

The regulatory environment also played a role in the shift: New rules crimped some of the traditional investment banking practices, or made them more expensive.

In the second quarter, the bank continued to trim back its "value at risk," a way of measuring potential trading losses and the risks that the bank is willing to take. Last year, the wealth management unit brought in more revenue than the investment bank. That's a significant change from earlier years. In 2008, the investment bank made up two-thirds of the company's revenue.

CLSA analyst Mike Mayo said Gorman's performance over the past four years had been mixed, and goals like sewing up the Smith Barney merger had taken longer than investors wanted. Still, he was optimistic about the bank's future, and last year upgraded it from a "sell' to a "buy."

"It's better late than never," Mayo said. "You wouldn't believe how many people I still talk to who say, 'Oh yeah, Morgan Stanley, all the problems.' ... But that's yesterday's news."

He and other analysts described the quarter as improved, though with some reservations.

"They're doing all these things that lay a clearer path to improved returns," said Shannon Stemm, an analyst at Edward Jones in St. Louis. "They still need to get there."

The bank's performance in trading bonds for clients, for example, has been inconsistent.

Financial measures like the return on equity, a gauge of profitability, are still well below where the bank would like them to be. In fact, the board of directors cut Gorman's 2012 pay partly because they were frustrated by the low returns.

The purchase of Smith Barney has been less than seamless. Combining the technology of the two brokerages has been expensive, and some employees have reportedly left over cultural differences. The bank, though, emphasizes that remaining employees are more productive than ever.

The stock buyback was enough to rev up investors on Thursday. When a company buys its own shares, it's a sign that it has confidence in itself and thinks the stock price will go up. The buyback also indicates that the Federal Reserve, which had to give its permission, is happy with Morgan Stanley's capital levels. Morgan Stanley hasn't bought back any of its shares since 2008.

Morgan Stanley earned $898 million in the quarter after excluding the benefit of an accounting gain, more than double the $337 million it made a year earlier.

That worked out to 45 cents a share after stripping out the gain and a charge for the purchase of Smith Barney. Financial analysts polled by FactSet had expected 43 cents. Analysts' expectations generally exclude one-time items.

Revenue in the investment bank jumped 40 percent after excluding the accounting gain. The bank traded more stocks on behalf of clients, underwrote more stock and bond offerings and advised more companies on strategy. Revenue from selling and trading bonds for clients also improved.

Other banks have reported strong results in investment banking, helped by surging stocks in late May that drew investors and companies to the market.

Revenue rose 10 percent in the wealth management unit, which advises small and medium-sized businesses and wealthy individuals.