Morgan Stanley rides debt wave

January 18, 2013, 7:47 PM UTC
Morgan Stanley CEO James Gorman

FORTUNE — Low interest rates and an increased desire by corporations and others to borrow powered Morgan Stanley to better-than-expected earnings in the last quarter of 2012.

Morgan Stanley earned nearly $900 million, or $0.45 a share, from continuing operations and after an accounting adjustment for its debt. That was much better than the $0.27 a share analysts expected. Earnings were also up compared to a year ago, when the company lost nearly $400 million. Revenue, excluding the adjustment for its debt, was also better than expected at $7.5 billion.

For all of 2012, the investment bank earned just over $3 billion from continuing operations and after the adjustment. That was up from a slight loss a year ago. Investors cheered the results. Shares of Morgan Stanley (MS) were up nearly 6% shortly after the market opened.

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Morgan Stanley’s earnings results follow a string of mostly positive reports from other large banks. Wells Fargo (WFC), Goldman Sachs (GS) and Bank of America (BAC) all reported better than expected earnings for the last three months of 2012. Citigroup (C), which has a new CEO and recently announced that it would cut 11,000 employees, was the only bank to disappoint for the quarter.

Morgan Stanley benefited from a better environment for deals on Wall Street in general. But it got its biggest boost from corporations and others looking to take advantage of low-interest rates. Bond underwriting fees rose 85% in the fourth quarter from the same period a year ago. Overall, sales and trading revenue was up nearly 50%. That, too, was propelled by a large improvement in Morgan’s bond and commodities business, which had struggled until recently.

Still, the report showed signs that the firm continued to struggle in the new, post-financial-crisis Wall Street. Morgan Stanley’s return on equity, a key measure of profitability, was a measly 3.2%. That was much worse than rival Goldman Sachs (GS), which reported earnings on Wednesday. Goldman’s ROE rebounded to 11%.

What’s more, nearly a third of Morgan Stanley’s revenue came from so-called principal transactions. Some or all of that revenue might be going away. New regulations seek to ban Morgan Stanley and other banks from making risky bets with their own money. The regulations aren’t finalized, though, and don’t go into effect for at least another year. Also, interest rates, which have been rising recently, might put an end to the debt issuance boosting Morgan Stanley.

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For the year, nearly every area of Morgan Stanley’s investment banking business showed a decline. Even Morgan Stanley’s stock underwriting business stumbled, despite being the lead underwriter of Facebook’s IPO last year. The deal, which came off much worse than expected, ended up being another black eye for the firm. Morgan Stanley recently agreed to pay a $5 million fine to the Massachusetts securities regulator to settle claims related to behavior of its lead banker surrounding the IPO.

The firm’s headcount reflected troubles at the firm, and on Wall Street in general. Morgan Stanley cut 700 staffers during the last three months of the year. The firm recently announced plans to lay off an additional 1,600 employees. Despite the cuts, Morgan Stanley still ended up spending 52% of its annual revenue on compensation. Activist hedge fund investor Daniel Loeb, who recently disclosed that he had been buying Morgan Stanley’s shares, has said that he thinks salaries at the firm, which have come down in recent years, are still too high. On average, Morgan Stanley paid its employees $273,777 in 2012. Goldman devoted just 36% of its revenue to compensation last year. Bowing to pressure, Morgan Stanley recently said it will pay much of its employees’ bonuses in stock, and that those shares will be deferred over three years.