DBRS: Morgan Stanley Ratings Unchanged After 3Q12 Earnings; Senior at A (high)

DBRS, Inc. (DBRS) has today commented on the 3Q12 results of Morgan Stanley (the Company). The Issuer & Senior Debt rating of A (high) and Short-Term Instruments rating of R-1 (middle) remain unchanged. The trend on the long-term rating remains Negative. For the quarter, the Company reported a net loss applicable to Morgan Stanley of $1.0 billion, which compares to net income applicable to Morgan Stanley of $563 million in 2Q12. However, DBRS notes that 3Q12 net income was negatively impacted by a significant debt valuation adjustment (DVA) loss of $2.3 billion (pre-tax), while 2Q12 results benefited from $350 million of pre-tax DVA-related gains. Excluding DVA, 3Q12 net income from continuing operations applicable to Morgan Stanley was $561 million, up from $338 million in the second quarter.

In DBRS’s view Morgan Stanley’s results reflected the generally improved market conditions relative to the second quarter. In Institutional Securities (IS) the company benefited from client re-engagement, though that should not mask what DBRS sees as a solid FICC performance for the Company and good Investment Banking (IB) results in a quarter characterized by generally lower M&A and IPO activity. DBRS also sees 3Q12 results as evidencing Morgan Stanley’s continued execution of its strategic initiatives aimed at enhancing its Global Wealth Management (GWM) franchise, optimizing capital and ultimately returning the Company’s earnings towards their full potential. However, it will take time to reach these goals. Combined with the current market uncertainties, DBRS views a Negative trend as appropriate for Morgan Stanley.

Excluding DVA, net revenues of $7.6 billion in 3Q12, were up by 14% QoQ. As noted, a more constructive trading environment boosted IS net revenues, though activity remains subdued. Excluding DVA, Fixed Income and Commodities Sales & Trading revenues of $1.5 billion in 3Q12 were up 89% from 2Q12, and reflected strong results in FX, rates and securitized products as well as a rebound in commodities from a difficult 2Q12. Equity Sales &Trading revenues grew by 7% from 2Q12 to $1.2 billion, excluding DVA, driven by better results for derivatives. Average daily trading VaR was $63 million in the quarter, down from $76 million in 2Q12. DBRS notes that Morgan Stanley implemented a new VaR model in the quarter. The new model has been run in parallel with the prior model since 2011. IB fees increased 10% QoQ to $969 million, driven by a 28% linked-quarter increase in fixed income underwriting. The Company reported subdued M&A volumes, though advisory revenues of $339 million were up 29% from 2Q12 and pipelines remain healthy. Within the IS segment, the compensation ratio on for the third quarter was 45% (ex-DVA), down from 49% in 2Q12.

Adding significant stability to Morgan Stanley’s quarterly revenue generation, GWM generated net revenues of $3.3 billion in 3Q12, in line with the quarterly run rate for the segment. Revenues in the third quarter reflected much stronger trading revenues which offset declines in investment banking revenues, commissions and fees, and asset management fees. Net interest income for GWM increased 5% QoQ to $410 million. Fee-based client account assets; an important revenue driver, increased by 6% QoQ to $556 billion (or 31% of total client assets) at quarter end. Excluding one-time expenses of $193 million related to integration and the purchase of an additional 14% stake in the Morgan Stanley Smith Barney Joint Venture, the pre-tax margin in GWM was 13% for the third quarter, up from 12% in 2Q12. Through ongoing expense discipline, continued growth in net interest income and managed assets, and by realizing the benefits associated with increasing its stake in the JV, DBRS sees the goal of a pre-tax margin in the mid-teens by 2013 as achievable for GWM. Of course, further improvement in market sentiment would also help on the revenue side.

Within Asset Management (AM), revenues improved to $631 million in 3Q12 from $456 million in 2Q12. Stronger revenues (up $137 million QoQ) from the more volatile Merchant Banking line, which reflected better market valuations for principal investments, drove the improvement. In Traditional AM, revenues increased 10% from 2Q12 to $372 million and also benefited from higher market levels. Market appreciation also drove assets under management up 6% QoQ to $331 billion.

DBRS views Morgan Stanley as appropriately refocusing its business mix towards more stable revenue sources, while continuing to maintain significant levels of liquidity and capital. The Company maintains a substantial liquidity buffer, which stood at $170 billion at 3Q12, or 22% of total assets. With respect to capital, Morgan Stanley maintains a comfortable cushion and has ample loss absorption capacity. The Company reported an estimated Basel I Tier 1 common ratio of 13.7% at 1Q12 and estimates that its Basel III Tier 1 Common ratio was above 9% at quarter end.

Notes:
All figures are in U.S. dollars unless otherwise noted.

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organizations. Other methodologies used include the DBRS Criteria – Intrinsic and Support Assessments. Both can be found on the DBRS website under Methodologies.

The sources of information used for this rating include company documents and SNL Financial. DBRS considers the information available to it for the purposes of providing this rating was of satisfactory quality.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.

Lead Analyst: Roger Lister
Approver: William Schwartz
Initial Rating Date: 31 July 1998
Most Recent Rating Update: 8 June 2012

For additional information on this rating, please refer to the linking document under Related Research.