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

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 remains Stable. These rating actions follows a detailed review of the Company’s operating results, financial fundamentals and future prospects.

In confirming the ratings with the Stable trend, DBRS is taking into account the strength of Morgan Stanley’s diversified franchise with a business mix that has been generating generally stable earnings, combined with a strong risk management framework that continues to evolve with the changing environment. The current ratings level also considers the continued headwinds facing the Company, including a still challenging operating environment and regulatory uncertainty, as well as Morgan Stanley’s exposure to wide ranging capital markets activities and diverse market risk, which support the franchise value but elevates risk levels. With a balance sheet that is largely mark to market (MTM), the Company is exposed to potential large market movements and market disruptions despite a lower risk profile.

DBRS sees upward pressure on the Company’s ratings as constrained by various factors including the still evolving regulatory environment and its potential impact on Morgan Stanley’s franchise. DBRS views the Company as having been successful in its efforts to modify its business model to cope with regulatory and legislative changes, with the current ratings incorporating the considerable progress Morgan Stanley has made in executing on its strategic plans. Over the longer-term, DBRS sees upward ratings movement as potentially being driven by the continued build-out of Morgan Stanley’s Wealth Management (WM) business, which provides more stability to earnings streams through relatively lower-risk lending, while also supporting the Company’s financial profile with a growing deposit base.

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 pressure ratings.

Morgan Stanley’s franchise is supported by a powerful, diverse Institutional Securities (IS) business, combined with a market leading WM franchise that adds stability and opportunity to leverage the franchise. Showing the global reach of its diverse franchise, 27% of the Company’s revenues were generated outside the Americas, 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 exit key business lines, while other competitors have been distracted by significant restructurings or other internal issues.

While Morgan Stanley has made considerable progress in executing on its strategic plans, DBRS views it as a challenge for Morgan Stanley to continue to deliver on its strategic initiatives in a still difficult operating environment. The Company will need to continue to make progress in utilizing its bank to facilitate diversification of revenues and earnings growth, by deploying its growing WM deposit base. While DBRS views Morgan Stanley as well-positioned to reap the benefits of a more substantial global economic recovery, it will remain challenged to manage a more complex, expanding organization in an evolving environment that is highlighted by regulatory change.

From an earnings perspective, Morgan Stanley reported another strong annual performance in 2014, with returns at the mid- to high-end of its global peer group. Net income (to common) of $3.2 billion on net revenues of $34.3 billion remains substantial, despite having been reduced by a $3.1 billion addition to legal reserves, and resulted in a return on average common equity of 4.8% (or 8.9% ex-legal reserves) for the year. This trend continued in 1Q15 with a return on average common equity of 14.2% in what is generally a strong quarter for capital markets businesses. Important to success across Morgan Stanley’s businesses is cost-efficient execution with strength in technology and systems providing a significant benefit.

Morgan Stanley’s risk management function is viewed internally as an important, core function to the overall strength of the franchise, and supports its ability to appropriately evaluate risk/reward. 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 has demonstrated its ability to cope with a stressed environment and adapt to a new normal, which includes a much higher level of regulatory scrutiny. Furthermore, the Company is benefitting from its more conservative risk profile, as it has aggressively reduced non-core exposures and risk-weighted assets (RWAs), while growing its lower-risk lending book as it deploys deposits from its WM business. Reductions in Value at Risk (VaR) indicate a lower level of market risk with average total management VaR of $47 million in 2014 versus peak VaR levels in excess of $150 million in 2009. Another indicator of risk-taking, daily trading net revenues, demonstrates more stable revenue generation in its diverse trading businesses with a fairly normal distribution and minimal days with large gains or losses.

Further underpinning the rating, Morgan Stanley has a sound financial profile. 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. Morgan Stanley has focused its funding profile toward more durable funding sources, including deposits, long-term debt, and equity, which comprised 77% of its funding stack at year-end 2014, up from just 43% at year-end 2007. The Company also maintains a significant level of liquidity, averaging $195 billion in 2014. As a bank holding company, Morgan Stanley has access to the Fed’s discount window, as well as other programs. This access gives the market an extra degree of confidence in the Company’s ability to weather another severe liquidity crisis. Additionally, Morgan Stanley has increased its capitalization, due partly to more demanding regulatory requirements. The Company reported a fully-loaded Basel III Common Equity Tier 1 (CET1) ratio under the advanced approach of 11.6%, and a Supplementary Leverage Ratio of 5.1% at 1Q15.

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 (June 2014). Other applicable methodologies include the DBRS Criteria – Support Assessments for Banks and Banking Organisations (March 2015) and DBRS Criteria: Rating Bank Capital Securities – Subordinated, Hybrid, Preferred & Contingent Capital Securities (February 2015). These can be found at: http://www.dbrs.com/about/methodologies.

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: July 31, 1998
Most Recent Rating: June 12, 2014