DBRS Confirms Ratings of Morgan Stanley, Revises Trend to Stable – Senior at A (high)

DBRS, Inc. (DBRS) has today confirmed the ratings for Morgan Stanley (or the Company), including its Issuer & Senior Debt rating of A (high) and Short-Term Instruments rating of R-1 (middle). The trend on all long-term ratings has been revised to Stable from Negative, while the trend on all short-term ratings remains Stable.

In revising the trend to Stable, DBRS is taking into account the strength of Morgan Stanley’s diversified franchise that has been successfully reoriented toward businesses that generate more stable earnings, while demonstrating solid performance across many of its capital markets businesses during an extended period of crises followed by uneven economic recovery. DBRS views the Company as having made significant progress in executing its strategic plans, positioning Morgan Stanley to reap the benefits of a more substantial global economic recovery. While the transition and execution phases of Morgan Stanley’s franchise reorientation took longer than anticipated, DBRS views the Company as having coped well during this period.

Underpinning the current ratings level are Morgan Stanley’s powerful, global Institutional Securities (IS) franchise and its industry-leading Global Wealth Management (GWM) business that are complemented by its sizeable, refocused Investment Management (IM) segment. Showing the global reach of its diverse franchise, about one-third of the Company’s revenues were generated outside the United States, reflecting its notable presence in Europe and Asia. DBRS also perceives that Morgan Stanley is benefiting from the disrupted competitive landscape that has seen certain competitors disappear and other competitors distracted by significant restructurings or other internal issues.

This action also reflects the increased resiliency of the Company’s underlying earnings. It reported another strong quarterly performance in 1Q14 in net income (to common) of $1.4 billion on net revenues of $8.8 billion. This follows net income of $3.0 billion on net revenues of $32.4 billion in 2013. The Company achieved these results despite headwinds that include an uneven global economic recovery, uncertainty regarding final regulatory requirements, and overall subdued client demand and risk appetite. Indicative of the Company’s successful refocusing of its business mix toward more stable revenue sources, close to half of its net revenues in 2013 and 1Q14 were attributable to its GWM and Traditional Asset Management businesses. Solid investment banking (IB) net revenues and a growing pipeline across products and regions demonstrate the strength and breadth of Morgan Stanley’s well-entrenched IB franchise.

In addition, DBRS views Morgan Stanley as having improved its risk profile. It has reduced non-core exposures and risk-weighted assets (RWAs), while growing its lower-risk lending book as it deploys deposits from its GWM business. Reductions in Value at Risk (VaR) indicate a lower level of market risk with average total management VaR of $59 million in 2013 versus average trading VaR of $129 million in 2011. Another indicator of risk-taking, daily trading net revenues, demonstrates more stable revenue generation in its diverse trading businesses. The distribution of daily trading revenues is fairly normal, with few days of large losses and big gains. Morgan Stanley generated positive net revenues ranging from $0 to $50 million in 55% of trading days in 2013, and negative net revenues were generated in just 13% of trading days. The Company had only 12 out of 260 days where its net trading revenues exceeded $100 million. While DBRS views the Company as still facing certain risks, given that its businesses are intertwined with financial markets that still face significant challenges, Morgan Stanley continues to demonstrate its ability to cope with a stressed environment and adapt to a new normal, which includes a much higher level of regulatory scrutiny.

Also important is Morgan Stanley’s success with its strategic plan, under which it has invested in the rebuilding and expansion of its client footprint and trading capabilities across its sales & trading (S&T) franchise, a key component of its IS segment. The Company continues to demonstrate progress in executing on this strategy in the capital markets businesses, with S&T net revenues up year-on-year (YoY) across all business lines to $3.1 billion (ex-DVA) in 1Q14. In Fixed Income and Commodities S&T, Morgan Stanley has laid out a plan to drive returns above its cost of equity by optimizing its commodities business through reducing exposure to physical commodities, improving efficiency through centralized management of resources, and further reducing RWAs, which are already down 46% from peak levels. In GWM, the Company has been successful in increasing its pretax margin (PTM) to 18% in 2013, up from just 7% in 2009. A new target range for PTM of 22-25% was announced earlier this year, which DBRS views as achievable given the Company’s continued success in deploying low cost deposits to fund increased lending within its bank. Further upside in earnings can be driven by expense reductions, with targeted run rate cost saves of $1.6 billion by year-end, with approximately $1.1 billion having been achieved by the end of 2013.

Underpinning the Company’s rating is also its strengthened capitalization and its enhanced funding and liquidity profile. With improved alignment of funding sources and uses, Morgan Stanley maintains a significant level of liquidity ($203 billion) and has focused its funding profile toward more durable funding sources, such as deposits, long-term debt, and equity. The Company continues to refine and strengthen its funding profile through the ongoing assessment of the characteristics of its diverse funding sources with those of the assets being funded. The Company’s estimated Basel III Common Equity Tier 1 (CET1) ratio stood at 14.1%, on a transitional basis and 11.6%, on a fully phased in basis, under the advanced approach at 1Q14. Its estimated supplementary leverage ratio is 4.2% at the parent holding company level. It expects to meet the 5% requirement by 2015.

While Morgan Stanley remains exposed to the potential recurrence of financial turmoil that could again lead to disrupted activities, reduced revenues and diminished investor confidence, DBRS perceives this risk as being appropriately factored into the current rating level. Negative rating action could arise if investor confidence is adversely impacted in a Morgan Stanley-specific scenario, which could particularly affect the Company given its sizable reliance on wholesale funding. Any indications of significant weakening in Morgan Stanley’s franchise or its ability to generate sustainable earnings could also negatively pressure ratings. While DBRS does not see any positive rating implications as likely at this time, further strengthening of underlying earnings, conservative risk management and continued strong financial profile would bode well from a ratings perspective.

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

The principal applicable methodology is the Global Methodology for Rating Banks and Banking Organisations. Other applicable methodologies include the DBRS Criteria: Support Assessment for Banks and Banking Organisations and DBRS Criteria: Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities. These can be found on DBRS website under Methodologies.

The primary 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: Lisa Kwasnowski
Rating Committee Chair: Alan G. Reid
Initial Rating Date: 27 January 2005
Most Recent Rating Update: 9 December 2013

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