DBRS: Morgan Stanley Ratings Unchanged After 4Q12 Earnings – Senior at A (high)

DBRS, Inc. (DBRS) has today commented on the 4Q12 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 net income applicable to Morgan Stanley of $507 million, which compares to a net loss applicable to Morgan Stanley of $1.0 billion in 3Q12. However, DBRS notes that 3Q12 net income was negatively impacted by a significant debt valuation adjustment (DVA) loss of $2.3 billion (pre-tax). Excluding DVA, 4Q12 net income from continuing operations applicable to Morgan Stanley was $894 million, up from $560 million in the third quarter.

DBRS views Morgan Stanley’s results as evidencing the Company’s continued execution of its strategic initiatives, which include expense reductions, lowering risk-weighted assets to optimize capital, and further investment in businesses that provide more stable revenue generation. Excluding DVA, net revenues of $7.5 billion in 4Q12 were largely flat from 3Q12 and slightly improved from net revenues, excluding DVA and one-offs, of $7.2 billion in 4Q11. In Institutional Securities (IS), the Company continues to work on enhancing collaboration with its Global Wealth Management (GWM) business to meet the needs of its expansive client base. Success within IS could be seen in rising revenues across regions and business lines, highlighted by record quarterly revenues in fixed income underwriting. Underwriting net revenues rose 22% QoQ driven by improved performance in EMEA and the Americas (Equity Underwriting) and by higher investment grade bond issuance and loan syndication fees (Fixed Income Underwriting). Advisory net revenues also rose reflecting higher levels of market activity. Furthermore, Sales & Trading (S&T) performance was boosted by Equities, where net revenue growth of 86% QoQ was driven by increased market activity in derivatives, higher volumes in cash equities, and stable performance in prime brokerage. On the other hand, Fixed Income and Commodities S&T net revenues (ex-DVA) declined on a sequential basis due to a significantly weaker environment for commodities and rates, despite maintaining client volumes. Within the IS segment, the compensation ratio for the fourth quarter was 43% (ex-DVA), down from 45% in the prior quarter. Non-compensation expenses also declined reflecting execution of previously announced cost initiatives.

Having acquired an additional 14% stake in MSSB during 3Q12, GWM generated net revenues of $3.5 billion in 4Q12, up 4% QoQ. Quarterly revenues reflected stronger investment banking revenues, commissions, and fees, and asset management fees, which offset declines in trading revenues that reflected markdowns in deferred compensation plans. Fee-based client account assets, an important revenue driver, grew 3% QoQ to $573 billion (or 32% of total client assets) at quarter end. The pre-tax margin in GWM was 17% for 4Q12, the highest since the inception of the JV as Morgan Stanley completed its integration process. DBRS views Morgan Stanley’s goal of maintaining a pre-tax margin in the mid-teens as sustainable, given the completion of the integration which has lowered costs and with further improvement in market sentiment that would help on the revenue side.

Within Asset Management (AM), net revenues fell 5% QoQ to $599 million impacted by the more volatile Merchant Banking line which reflected lower principal investment gains. In Traditional AM, revenues were flat from 3Q12 at $376 million. Market appreciation and net asset inflows drove assets under management up 2% QoQ to $338 billion.

In addition to quarterly results, Morgan Stanley provided an update to its strategic plan, which includes an additional $1.6 billion in targeted cost reductions over the next two years. The strategic plan calls for further reducing and re-sizing of its IS geographic footprint and headcount reduction, among other initiatives. Having already recognized $500 million in cost reductions in 2012, DBRS views this as achievable for the Company and will continue to monitor its progress.

The Company maintains a substantial liquidity buffer, which stood at $182 billion at year-end, or 23% of total assets. With respect to capital, Morgan Stanley maintains a comfortable cushion and has ample loss absorption capacity, in DBRS’s opinion. The Company reported an estimated Basel I Tier 1 common ratio of 14.7% and estimates that its Basel III Tier 1 Common ratio was 9.5% at year-end.

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

[Amended on June 25, 2014 to remove unnecessary disclosures.]