Morgan Stanley stumbles in latest quarter

NEW YORK (CNNMoney.com) -- Morgan Stanley revealed just how vulnerable its business became during the recent credit crisis when it reported quarterly earnings Wednesday that missed Wall Street forecasts.

The New York-based investment bank said its income from continuing operations fell to $1.47 billion, or $1.38 per share, during the third quarter ended Aug. 31, from $1.59 billion, or $1.50 a share, a year earlier.

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Revenue climbed 13 percent to $8 billion from a year earlier.

Analysts however had forecast profits of $1.54 a share on revenue of $8.35 billion, according to earnings tracker Thomson Financial.

Morgan Stanley (Charts, Fortune 500) shares slipped 2.7 percent in Wednesday afternoon trade on the New York Stock Exchange.

"This has been a quarter with many challenging market dynamics," said David Sidwell, Morgan Stanley's chief financial officer, in a conference call following the release of the company earnings.

Morgan Stanley cited a sharp decline in revenue at its fixed income sales and trading division and said it had to take a write-down totaling $940 million to reflect the market value of certain loans on its books, blaming "illiquidity created by current market conditions."

Lehman Brothers (Charts, Fortune 500), which delivered surprisingly strong earnings just a day earlier, said it had to write-down $700 million in loans in the most recent quarter.

The Wall Street bank also suffered losses totaling $480 million in its quantitative, or computer-driven, investments, which were hit hard during the month of August amid extreme volatility in the stock market.

While its leveraged lending, credit product and commodity revenues also suffered, Morgan said its losses were softened by the performance of its currencies and prime brokerage businesses.

Dick Bove, an analyst with Punk Ziegel & Co., said this quarter's results reflect an ill-timed committment by Morgan to riskier areas such as alternative investments and private equity.

"As this firm moved out on the risk spectrum, it left itself exposed to more losses in a period of weakness in the cycle which is what we are seeing in the numbers today," said Bove.

Morgan Stanley's Colm Kelleher, head of the company's global capital markets division and incoming CFO, warned Wednesday that the company remained exposed to a number of risky investments, but did not alter the company's fourth-quarter or full-year outlook.

Kelleher also said he expected that it would take a quarter or two for credit markets to return to more normal levels, while he applauded the Federal Reserve's decision to cut interest rates Tuesday.

"The Fed action of yesterday was welcome, but is a first step," said Kelleher.

Morgan Stanley was the second big Wall Street bank this week to report earnings so far this week, with both Bear Stearns (Charts, Fortune 500) and Goldman Sachs (Charts, Fortune 500)on deck to deliver their quarterly results Thursday.

Wall Street has been closely scrutinizing financial sector results for signs about the scope of the subprime mortgage meltdown and larger credit crisis.