Morgan Stanley: Morgan Stanley might look like it’s the only investment bank that couldn’t make money last quarter. But strip out all the one-off funnies and the Wall Street firm’s $159 million reported loss actually turns into some tolerable core earnings.

Getting there involves adding a few items back to revenues. First, the $2.3 billion hit Morgan Stanley had to take as the credit spreads on its own debt improved – the result of a 2007 accounting change that forces firms to record gains as their liabilities slip in value and losses if they increase.

Next, fold back in the $850 million it paid to get out of the US government’s Troubled Asset Relief Programme, and, just to be generous, the charge for swapping some preferreds held by Mitsubishi Financial into stock, Smith Barney merger costs and a one-off special assessment levied by the Federal Deposit Insurance Corporation.

All in, that boosts overall revenue to $8.9 billion, leaving Morgan Stanley with $2.9 billion in pre-tax earnings. Assuming the quarter’s whopping 54 percent tax bill still applies, that leaves a profit of $1.33 billion. On an annualised basis, that makes for a return on equity of some 9 percent. That’s far better than the paltry 0.3 percent first-quarter showing. But the results still stand out as sub-par compared to rivals.

Much of the problem comes in fixed income. Granted, $2.5 billion of revenue – after adding back charges on Morgan Stanley’s own liabilities – looks pretty good for a firm that has disavowed prop trading. But with Citi and JPMorgan reporting twice as much and Goldman Sachs and Bank of America even more than that, Morgan Stanley looks rather shy – and insiders say it pulled its punches in both currencies and the rates business. Also, Morgan Stanley’s asset management division is still losing money, largely because of principal investments.

That leaves the firm rather caught between two stools: its trading results are suffering because it isn’t taking enough risk while investments are still suffering because it took too much.

The good news is that once properly up and running the brokerage joint venture with Smith Barney should post better results and boost returns. But until it is clear exactly what the firm’s tolerance for risk is, Morgan Stanley’s shareholders are likely to tread a cautious path.

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Morgan Stanley reported a second-quarter loss of $159 million, or $1.37 a share, missing the consensus estimate of a loss of 54 cents a share.

The firm recorded investment banking fee revenue of $1.1 billion, equity trading revenue of $681 million and fixed income trading revenue of $973 million. Overall, the investment bank recorded a pre-tax loss of $307 million, global wealth management a loss of $71 million and asset management a loss of $239 million.

The loss was driven by two factors. First, the firm took a $2.3 billion revenue hit as spreads on its own liabilities improved during the quarter. Under US accounting rules, financial firms must mark to market changes in the spreads of their own debt: as spreads widen – as they did as the credit crisis worsened – firms record a gain; as spreads narrow, they record a loss.

Second, Morgan Stanley paid a one-off $850 million preferred dividend related to paying back the $10 billion in capital it received from the US government’s Troubled Asset Relief Programme.

Elsewhere, Morgan Stanley took a $202 million hit from the partial exchange of preferred stock issued to MUFG for common stock and a $319 million after-tax gain from selling its remaining stake in MSCI.

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