* Commodities risk highest since 2008 but doesn't pay off
* Fixed income and commodities revenue drop sharply (Adds details, context, peer comparisons)
By Barani Krishnan
July 19 Morgan Stanley's commodities trading risk shot to pre-financial crisis highs during the second quarter but revenue from the sector and other trading fell, showing that its bid to buck Wall Street's lower-risk approach did not pay off.
The only major U.S. investment bank to keep risk up while navigating tough oil, metals and grains markets in the three months to June, Morgan Stanley's Value-at-Risk (VaR) in commodities rose to its highest since the second quarter of 2008.
In comparison, arch rival Goldman Sachs slashed its commodities VaR to 8-year lows during the same period.
J.P.Morgan, the largest U.S. bank and last year's highest earner in commodities among the three, trimmed risk in the sector to the lowest since 2010.
While Morgan Stanley outdid its peers on commodities risk, it didn't have the results to show for it.
Wall Street banks typically do not break down their commodity earnings but declare them under a "fixed income" category, which includes receipts from bonds and currencies. Morgan Stanley said that excluding accounting gains, net revenue for fixed income and commodities sales and trading slumped to $770 million during the second quarter from $1.9 billion a year ago.
"I think really what it was is when the volatility in commodities picked up, Morgan Stanley did not handle it that well, and that's partly reflected in its share price today," said Matt McCormick, a portfolio manager at Bahl & Gaynor Investment Counsel in Cincinnati, Ohio, who follows banks.
Morgan Stanley's stock fell more than 4 percent to below $13.40 a share after it reported a 24-percent drop in revenue for the second quarter on Thursday, despite earning a net profit compared to a loss in the first quarter. It also announced plans to cut as much as 7 percent of its staff this year.
In its quarterly report, the bank said it experienced a "challenging" environment for fixed income and "reduced levels of client activity," using language similar to that of peer Goldman Sachs in its recent earnings report.
Client activity refers to trading and hedging done by Wall Street banks on behalf of customers. Since 2010, most U.S. investment banks say they have barely traded for their own accounts after new financial laws were passed to restrict proprietary trading that once brought them huge profits and were blamed in part for excessive risks taken during the financial crisis.
TOUGH COMMODITIES QUARTER
Commodity prices experienced some of their wildest swings in the three months to June, scaring many investors away and into the relative safety of U.S. Treasuries and the dollar.
After comparatively mild moves in April, commodity prices plunged in May and continued a broad downtrend until a violent snap back on the last trading day of June.
The 1 percent drop on the benchmark Thomson Reuters-Jefferies commodities index in April - followed by an 11 percent slump and 4 percent gain in subsequent months - tripped up some of the biggest speculators in the sector, including hedge funds which posted sharp losses.
Morgan Stanley said its commodities VaR averaged $34 million per day in the second quarter - a rise of 10 percent from $31 million in the first quarter and up 17 percent from $29 million in the second quarter of 2011.
VaR is an important consideration for investment banks when making trading and hedging decisions for an asset class. Since Wall Street banks do not break down their commodity receipts, the VaR is also often the best guide to their exposure in that area.
Like Goldman and J.P. Morgan, Morgan Stanley's VaR readings are based on a 95 percent confidence level of the potential loss it could make in trading commodities and other assets over a one-day time horizon.
Commodities VaR at leading Wall Street banks over the past two years (in $ millions):
Average commodities VaR by quarter
2Q12 1Q12 4Q11 3Q11 2Q11 1Q10 4Q10 3Q10 2Q10
* JPMorgan 13 21 20 15 16 13 14 13 20
* Goldman Sachs 20 26 26 25 39 37 23 29 32 * Morgan Stanley 34 31 28 32 29 33 26 30 29
* Bank of America n/a 13.1 12.1 15.7 23.7 23.9 17.7 19.4 23.2 ** Citigroup n/a 14 18 22 25 23 27 26 21
* Value-at-Risk based on a 95 percent confidence level ** Value-at-Risk based on a 99 percent confidence level Note: Bank of America has issued second quarter results but its VaR readings are reported in a separate regulatory filing. Citigroup, which will release Q2 results on July 20, also reports VaR in a later filing. (Reporting by Barani Krishnan; Editing by Bernadette Baum)
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