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Morgan hints firm may allow best interest contract exemption

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Morgan Stanley net revenue was a record $3.9 billion, up 7% year-over-year, according to the wirehouse, which hinted in an earnings call that it may allow advisers to use the best interest contract under the Department of Labor's fiduciary rule.

CEO James Gorman told analysts the wirehouse will be making an announcement relating to the rule in coming weeks. He offered no more specifics, but said it was "fair to say" that the firm was committed to optimizing choices for its clients. "Giving them a choice of how they deal with the firm, services they access, how they pay for those services, is critical to how we operate as a firm."

Analysts at Keefe, Bruyette & Woods took that as a sign the firm was willing to allow the exemption in brokerage IRA accounts. Wirehouse rival Merrill Lynch earlier this month announced it would not allow advisers to use the exemption, which permits firms to continue to offer commission-based accounts. Critics charge that the liability risk associated with the exemption is too high.

A commentary released by KBW's analysts after the earnings call notes that wealth management was 45% of Morgan's 2015 revenues, compared to 21% at Merrill Lynch's parent company, Bank of America. "[Morgan Stanley] may have decided that the risk of losing FAs to competitors due to the decision not to use the exemption was too great," the analysts wrote.

The latest earnings show adviser headcount at Morgan was 15,856, down 53 from the previous quarter.

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Noninterest expenses for wealth management increased to $2.89 billion, up 6% but was offset by better performing revenues which left pre-tax income from continuing operations 9.3% higher year-over-year, the firm reported.

Expenses related to compensation were $2.2 billion for the quarter, a 10% increase from the prior year period. Morgan blamed an increase in the fair value of deferred compensation plan referenced investments for the jump.

Breaking down Morgan's wealth management revenues, asset management fees took a 4.5% hit, reflecting a lower average fee rates on fee-based accounts, but transactional revenues which included revenues from investment banking, trading, commission and fees increased by 21.4% year-over-year. The growth was a result of gains on investments from certain employee deferred compensations plans compared with losses in the prior year period, according to Morgan.

Higher deposit and loan balances drove up net interest income to $885 million from $751 million a year ago.

Client assets were $2.09 trillion, 9% higher this past quarter compared to the year before period.

Overall, Morgan reported a 57% increase in firmwide profits as fixed-income trading revenue almost tripled, the biggest surge for that business on Wall Street. Gorman said the overall results reflected a "steady progress" against the firm's "long term strategic goals."

Net income rose to $1.6 billion or 81 cents a share, from $1.02 billion, or 48 cents, a year earlier, according to Morgan. The 2015 figure includes 14 cents a share from an accounting adjustment that was discontinued after a rule change. Profit from continuing operations was 80 cents a share, beating the 63-cent average estimate of 22 analysts in a Bloomberg survey.

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Gorman has sought to convince investors he can lower costs while steadying profit from bond trading, a business that weighed on returns in the past. The 58-year old CEO said in June that the fixed-income and commodities business can generate $4 billion in annual revenue even after his decision to cut a quarter of the division’s staff last year.

“We had a better quarter,” Gorman said on a conference call with analysts. “What I’m pleased about is we did it with 25% less people.”

Fixed-income trading revenue rose to $1.5 billion, exceeding analysts’ estimates of $1 billion. Equity trading climbed 5.6% to $1.9 billion, compared with the estimate of $1.83 billion.

“Fixed income was quite strong this quarter,” CFO Jonathan Pruzan said in an interview. “It was a better trading environment for us, particularly given our skew toward credit. The credit environment was quite good in terms of tightening spreads” and bond purchases by the European Central Bank, he said.

Return on equity was 8.7% in the third quarter. The firm’s target is 9% to 11% by the end of 2017.

Morgan climbed 0.7% to $32.55 at 10:20 a.m. in New York. The shares are up 2.3% this year, outpacing the 1.1% gain for the 64-company S&P 500 Financials Index.

Companywide revenue rose 15% to $8.91 billion, exceeding the $8.14 billion estimate of 18 analysts surveyed by Bloomberg.

With additional reporting by Bloomberg News.

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