Third quarter results at Morgan Stanley (MS) — one of only two independent investment banks left, after the collapse of many previous competitors — were down but clearly far from horrible. On Tuesday, the Wall Street firm reported a better-than-expected 7.7 drop in profits, as net revenues rose; the company recorded a profit of $1.43 billion, or $1.32 per share, compared to $1.54 billion, or $1.44 per share, in the year-ago period. But better-than-expected results apparently have done little to quell speculation that the company may merge with a bank. Part of the reason is that Morgan Stanley benefited from the same accounting quirk that has helped more than a few monolines in recent periods: a sharp drop in the value of Morgan Stanley debt (reflecting investor concern) led the firm to book $1.4 billion in paper gains. We’ll spare readers a discussion of further accounting vagaries here. In terms of mortgages, Morgan Stanley’s fixed-income revenue — which include its mortgage business — registered $1.9 billion for Q3, recovering from a horrible Q2 and off roughly 8.5 percent from one year ago. In Q2, fixed-income trading revenue had plunged 85 percent, in contrast. Net exposure to non-subprime residential mortgages and associated securities fell from $6.7 billion at the end of May to $6.5 billion at the end of August, the company said; but net exposure, the result largely of changes in hedging, masked a steeper pullback in Alt-A mortgages during the quarter. Morgan Stanley said it trimmed holdings of non-subprime RMBS by 20 percent during the quarter. Analysts generally bumped their profit estimates for the firm upward on Wednesday morning; Reuters reported that Wachovia Securities had increased its 2008 profit estimates by 8 percent to $4.89 per share. Independent, but for how long? Despite the better-than-expected results, speculation continued to mount Wednesday that Morgan Stanley may need to find a partner in a commercial banking outfit; shares were pressured heavily during morning trading, and were at $24.11, down a sharp 16 percent from opening prices. Of the five major U.S. independent investment banks — Bear Stearns & Cos., Goldman Sachs (GS), Lehman Brothers Holdings Inc. (LEH), Merrill Lynch & Co. (MER), and Morgan Stanley — only Goldman and Morgan are left standing as independents. And Morgan Stanley soundly outshone Goldman in terms of Q3 earnings. None of which matters in a market so uncertain as this one. CNBC reported late Tuesday that further stock pressure may force the investment bank to find a buyer, regardless. “Senior people at Morgan concede that further zig-zags in the company’s stock price could and possibly will force the company to change course and seek a merger partner, probably a well capitalized bank,” the CNBC story said. Street traders clearly were betting in the direction of some sort of merger late Tuesday, with credit default swaps soaring Tuesday, despite the earnings announcement, approaching levels seen for Lehman — which already has filed for bankruptcy. The CNBC reported cited an unnamed source as saying that Morgan Stanley CEO John Mack doesn’t want to follow the footsteps of Lehman Brothers CEO Richard Fuld, by waiting too long to make a move. Morgan Stanley press representatives had not commented on the report by the time this story was published. Disclosure: The author held no relevant positions when this story was published; indirect holdings may exist via mutual fund investments. HW reporters and writers follow a strict disclosure policy, the first in the mortgage trade.