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Portfolio Update

Learning from Earnings

By Elliott H. Gue, on Jan. 31, 2014

Morgan Stanley posted strong-fourth quarter net revenue of $7.8 billion and earnings applicable to common shareholders of $133 million, or $0.07 per share. These results include $1.2 billion of legal expenses, a $192 million tax benefit and a $368 million debt valuation adjustment.

The investment bank’s institutional securities segment continued its strong performance, earning top three rankings in global mergers and acquisitions (M&A) and global equity and initial public offerings.

Management expects M&A activity to remain robust in the coming year, especially cross-border deals. Equity underwriting likewise remains strong, while debt underwriting stands to benefit from event-related financings.

During the fourth quarter, Morgan Stanley sold its oil trading unit to Rosneft (Moscow: ROSN, OTC: OJSCY). The divestment will appease regulators while further reducing the investment bank’s risk-weighted assets and bolstering its return on equity (ROE).

Morgan Stanley’s general partner interest in oil and refined-products terminal owner TransMontaigne Partners LP (NYSE: TLP) is also on the sales block.

Potential acquirers include Lifelong Income Portfolio holding Kinder Morgan Energy Partners LP (NYSE: KMP), which has a 50-50 joint venture with TransMontaigne Partners on the Gulf Coast.

The investment bank aims to earn a ROE of 10 percent in its fixed-income and commodities business.

More important, the second half of 2013 marked the first six months during which Morgan Stanley exercised full control over its former joint venture with Citigroup (NYSE: C).

This acquisition is at the center of CEO James Gorman’s plan to expand profit margins and bolster the investment bank’s return on equity.

Management earlier this year had called for the wealth management business to deliver profit margins of 20 percent to 22 percent by the end of 2015, but strong equity markets and cost savings enabled the business line to hit the low end of this estimate in the fourth quarter.

Accordingly, Morgan Stanley hiked wealth management’s targeted profit margins to between 22 and 25 percent over the next two years. As before, this forecast doesn’t factor in any contribution from rising interest rates, suggesting that actual profitability could outstrip this goal.

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