Income rose in all the bank's businesses. Profit from trading and investment banking was nearly six times higher than a year earlier, helped by stronger stock and bond trading, and profit for Morgan Stanley in wealth management jumped 83 percent.
The bank said regulators approved its buying back $500 million of its stock, and Morgan Stanley shares rose 5 percent in midday trading. The buybacks would represent the first time the bank has repurchased shares since the 2008 financial crisis.
Chief Executive James Gorman has been trying to fix Morgan Stanley, which suffered big losses during the crisis. He has been focusing on measures such as improving profitability in the bond trading business and the wealth management unit, which until June was a joint venture with Citigroup Inc (C.N).
"They've been talking about some of these plans for a long time but weren't reaching the targets ... But now, they're finally showing progress," said Shannon Stemm, an analyst with Edward Jones who covers Morgan Stanley.
But Gorman still has work to do. Morgan Stanley's return on equity, a measure of how effectively the bank wrings profit from shareholders' money, was just 5.2 percent in the latest quarter. That is up from 3.7 percent a year earlier but less than half of what investors expect. Rival Goldman Sachs Group Inc (GS.N), the No. 1 U.S. investment bank, posted a return on equity of 10.5 percent for the second quarter.
Net income attributable to common shareholders rose to $802 million, or 41 cents per share, in the second quarter from $564 million, or 29 cents per share, a year earlier.
Excluding special items, Morgan Stanley earned 45 cents per share, beating analysts' average estimate of 43 cents, according to Thomson Reuters I/B/E/S.
The latest results included a gain related to changes in the value of the bank's own debt, largely offset by a charge from buying Citigroup's remaining share of the wealth management business.
Revenue rose 22 percent to $8.50 billion, while expenses rose 12 percent to $6.73 billion, signaling that the bank is keeping a lid on cost growth. Analysts usually look for banks' revenue growth to exceed cost growth.
Morgan Stanley has achieved its targets for expenses, Ruth Porat, the bank's chief financial officer, said in an interview with Reuters.
"But we are continuing to focus on expense reduction. There's more to do," she added.
Morgan Stanley is the last of the big five Wall Street banks to report second-quarter earnings.
Like Goldman Sachs, JPMorgan Chase & Co (JPM.N), Bank of America Corp (BAC.N) and Citigroup, Morgan Stanley easily beat analysts' profit expectations, thanks largely to strength in trading and underwriting early in the quarter before bond yields spiked.
Higher yields can cut into client demand to issue bonds, and can reduce trading volume if investors rush for the sidelines.
MOVING PAST THE DOWNGRADE
Morgan Stanley's strategy for improving returns in its fixed-income business includes reducing assets there. Adjusting for risk, it had hoped to reduce those assets to less than $255 billion by the end of this year, but it reached that goal in the first quarter.
At the end of the second quarter, its risk-weighted assets in fixed-income trading were $239 billion, close to the bank's goal of $235 billion by the end of 2014.
"We're well ahead of our targets," Porat told Reuters.
Reducing assets in fixed-income trading will also help the bank meet leverage requirements under proposed new U.S. rules, Porat said on a conference call. The bank's leverage ratio, which compares equity to assets, was about 4.2 percent at the end of the second quarter. The proposed requirement is 5 percent; Morgan Stanley believes it can meet that level by 2015.
Stock trading revenue jumped to $1.8 billion from $1.3 billion a year earlier, excluding the debt valuation adjustment, or DVA, which reflects gains and losses on banks' own debt.
Revenue from fixed income and commodities trading rose 50 percent to $1.15 billion, excluding DVA.
Last year's figures were hurt by a downgrade of the bank by Moody's Investors Service in June. Anticipation of the downgrade during the quarter cut into Morgan Stanley's bond trading revenue in particular.
Morgan Stanley had set a quarterly revenue benchmark for fixed income and commodities trading revenue of $1.5 billion, saying this is necessary to meet its cost of capital following a disappointing first-quarter.
As with its rivals, underwriting was a bright spot in the second quarter. Debt underwriting revenue rose 24 percent to $418 million, while equity underwriting revenue increased 16 percent to $327 million.
Advisory revenue rose 27 percent to $333 million despite weak M&A activity.
Wealth management revenue rose 10 percent to $3.53 billion, representing a profit margin of 18.5 percent.
Gorman is targeting a profit margin of at least 20 percent for the wealth management business by 2015, and has said the margin could top 23 percent if interest rates rise and market conditions improve.