NEW YORK (Reuters) - Morgan Stanley (MS.N) reported a surprising third-quarter loss, suggesting the bank is losing hard-won ground in the battle with Goldman Sachs (GS.N) for Wall Street supremacy.
The firm's $91 million (57 million pound) loss, on weak volumes during one of the most difficult trading quarters in recent memory, came a day after Goldman overcame those same conditions to beat Street estimates with a $1.9 billion profit.
Despite results that could have spooked Wall Street a few quarters ago, Morgan Stanley shares were just fractionally lower in afternoon trading and the broader market was higher, the latest sign of a decoupling of banks from wider investment sentiment.
"Morgan Stanley is a caterpillar in metamorphosis. It's either going to turn into a beautiful butterfly or get eaten by a robin," said Brad Hintz, an analyst with Sanford C. Bernstein.
"You could look ahead and say I'm going to like the future Morgan better than I'm going to like the future Goldman, but you're still going to have a period that's pretty rough on the stock."
The leading investment banks have gone in different directions since the financial crisis: Morgan Stanley has rebalanced its business to include the largest retail brokerage, while Goldman has stuck to its banking and trading roots.
Morgan Stanley Chief Executive James Gorman acknowledged on Wednesday that the bank remains a "work-in-progress" -- and warned investors to expect more growing pains due to the financial reform law that restricts proprietary trading and hedge fund ownership by banks.
"The regulatory changes are real, permanent and will fundamentally reshape the industry," Gorman said on a conference call with investors and analysts.
The bank said on Wednesday that, as expected, it was restructuring its ownership of hedge fund unit FrontPoint Partners LLC, in part to comply with the reform law's "Volcker rule" on hedge fund assets. Morgan Stanley will retain a minority ownership in FrontPoint.
Morgan Stanley knows it has work to do to catch up to Goldman in fixed income trading, which powered the banking industry's rebound from the financial crisis. Its third-quarter fixed income net revenue was down by more than half from a year earlier.
The firm's "results are very disappointing -- the worst so far in the investment banking sector," analysts at JPMorgan wrote in a report.
Morgan Stanley Chief Financial Officer Ruth Porat said the bank's efforts to rebuild its fixed income trading ranks have further to go, and it remains outnumbered by its peers.
"We have repeatedly said that fixed income is the area we need to build up," Porat told Reuters in an interview.
She said third-quarter results were hurt by the accounting ramifications of improvements in the bank's debt prices, but added that the trading results "were nothing to be proud about."
Porat said Morgan Stanley's trading desks struggled in a tough environment in which it already had lower market share than some of its rivals.
Morgan Stanley, based on one measure, boosted its risk-taking in the third quarter, even as rivals like Goldman reined in risk.
Morgan Stanley's average "value-at-risk" -- a measure of the maximum possible losses the bank will face on 95 percent of its trading days -- was $142 million in the third quarter, up from $139 million in the second quarter. Goldman reported a VaR of $121 million, down from $136 million in the second quarter.
Under Gorman, who took over as CEO on January 1, Morgan Stanley has been focussed on building the Morgan Stanley Smith Barney joint venture, the largest retail brokerage. The bank spent $83 million on integrating the joint venture during the third quarter, Porat said during the conference call.
The bank's global wealth management business did not offer much relief from the trading woes in the third quarter, reporting net revenues of $3.1 billion, up just 1 percent from a year earlier. Morgan Stanley said lower levels of client activity weighed on its retail brokerage results.
Porat said Morgan Stanley is still confident the wealth business will help balance the firm's operations.
"We still see multiple legs of the stool working together to create a more balanced business," she told Reuters.
Morgan Stanley's strategy of building its wealth business was also designed to help the firm prepare for the financial reform law's more stringent regulations on trading.
The bank reported a third-quarter net loss applicable to shareholders of $91 million, compared with a profit of $498 million a year earlier.
Income from continuing operations was 5 cents a share. Analysts' average forecast was 15 cents, according to Thomson Reuters I/B/E/S.
Morgan Stanley said its results reflected a writedown of $229 million related to Revel Entertainment Group, a troubled hotel and casino project in Atlantic City, New Jersey.
The bank's shares were down 13 cents, or 0.5 percent, to $25.26 in afternoon trading.
(Reporting by Steve Eder; additional reporting by Maria Aspan; editing by John Wallace)