NEW YORK, US - THE two largest US investment banks, Goldman Sachs and Morgan Stanley, reported lower quarterly profits, but beat expectations on Tuesday even as the worst market slump in decades rattled Wall Street.

Goldman Sachs said its third-quarter earnings plunged 70 per cent on weaker-than-expected revenues, knocking its shares to nearly three-year lows.

Smaller rival Morgan Stanley, which reported after the close of North American markets, trounced expectations partly on the back of strong equity trading results.

Morgan's earnings fell less than 3 per cent even as the year-old credit crunch slowed deal activity and created one of the toughest trading environments in decades.

'Between Goldman Sachs and Morgan Stanley, we are getting some modest positive news in what has been an otherwise dark five-day period,' said Mr Keith Wirtz, president and chief investment officer of Fifth Third Asset Management.

After closing down 11 per cent, Morgan Stanley shares gave up after-hours gains of nearly 9 per cent to trade around their close of US$28.70 (S$41.12).

With Lehman Brothers filing for bankruptcy and Merrill Lynch & Co rushing into the arms of Bank of America Corp in the last couple of days, questions have grown about the viability of the financial sector as it stands.

But Morgan Stanley Chief Financial Officer Colm Kelleher told Reuters he remains confident in the broker-dealer model and dismissed the need to merge with a deposit-taking bank.

'I'm very confident about the business model. I'm clearly cautious about the markets,' he said.

On a conference call with investors, Mr Kelleher said he hoped the results would serve as 'a building block in a bridge to rebuilding confidence in this market.

'Things are frankly getting out of hand,' he said.

'Ridiculous rumours are being repeated, some of which if I wrote down today and re-read tomorrow, I'd probably think I was dreaming.'

The investment bank said US$2.7 billion in revenue from equity sales and trading included record results in prime brokerage. Results also included a US$745-million pre-tax gain related to the follow-on offering of index company MSCI.

'This is great news for the whole financial sector,' said Mr Marshall Front, chairman at Front Barnett Associates. 'I think the key to this whole thing was that they looked better than Goldman Sachs' earnings earlier in the day.'

Biggest decline since 1999
Goldman Sachs' results were marked by sharply lower banking, trading and investment results. It was the investment bank's biggest earnings decline since it went public in 1999.

Goldman beat profit expectations, despite US$1.1 billion in write-downs and losses from principal investments.

Goldman shares closed down 1.8 per cent after falling as much as 14 per cent early in the session.

Some investors said Goldman deserved credit for reporting any profit at all, while its executives expressed confidence in the firm's business model.

'For them to perform in this manner, in this environment, is nothing short of heroic,' said Holland & Co Chairman Mike Holland.

Last week, Lehman Brothers reported a quarterly loss of US$3.9 billion, fuelled by nearly US$8 billion in write-downs. The losses and worries about a lack of capital ultimately forced the 158-year-old firm into bankruptcy.

The shares of big insurer American International Group Inc , a leading underwriter of credit default swaps, sank 21 percent on Tuesday on worries that it too would go bankrupt.

'People were hoping for some good news in a sea of gloom and I don't think they got it,' said Mr Matt McCormick, portfolio manager and analyst at Bahl & Gaynor Investment Counsel.

Half a trillion
Banks and brokers have recorded more than half a trillion dollars in write-downs over the past year as the US mortgage crunch has widened into a full-blown credit crisis that shows no signs of abating.

Goldman so far has navigated the turmoil better than its peers, avoiding big write-downs.

Yet Goldman executives acknowledged their business follows the global economy and that, right now, conditions are grim.

In response, the company is playing defense - hoarding capital and cash, and shedding risky assets.

'We've become even more cautious in our approach,' Chief Financial Officer David Viniar told reporters. 'There's a lot of fear in the marketplace.'

Earnings beat analysts' reduced expectations of US$1.75 a share, but revenue fell short of the consensus target of US$6.3 billion, according to Reuters Estimates.

On Monday, Goldman shares dropped 12 per cent to a five-year low, the biggest one-day drop in more than eight years.

With three of the top five US investment banks - Lehman Brothers, Merrill Lynch and Bear Stearns - leaving the stage, some analysts have speculated Goldman and Morgan Stanley could themselves face market pressure. Several observers forecast Goldman would acquire a deposit-rich bank to provide stable funding in jittery markets.

Yet Mr Viniar batted down suggestions that investment banks need to merge with commercial banks to save themselves.

'It's not the business model. It's performance that matters,' he said. 'We've been able to compete just fine.'

As expected, Goldman's investment banking revenue dropped 40 per cent amid a dearth of deal activity. Fixed-income trading revenue plummeted by two-thirds, reflecting weak credit and mortgage trading results. Equities trading revenue fell by one- half in a period when many investor clients were forced to 'de-leverage,' or sell off their holdings.

The latest quarter included $1.1 billion in losses on corporate loans, residential and commercial mortgages, all areas where Goldman has been trying to trim its exposures.

Moreover, the firm lost US$453 million on principal investments, showing the occasional downside of making aggressive bets with house money. Asset management revenue fell 6 per cent, reflecting declining markets and clients withdrawing a net US$7 billion of assets from funds.

One bright spot was a 20 percent jump in securities services, reflecting in part a strong increase in prime brokerage services for hedge funds.

Also, the backlog of pending investment banking deals increased in the quarter, Viniar said, fueled by new M&A advisory assignments. That increase could lead to rising revenue in future periods as deals are completed.

Some analysts said Goldman beat expectations because it paid unusually low taxes, an effective rate of 12 percent compared with 34 per cent last year. That alone boosted earnings by 32 cents a share. -- REUTERS