DBRS: MS’ 3Q Hurt by Weak 3Q Sales & Trading; YTD Net Revenues Still Higher

Summary:
• Net income to common of $939 million on net revenues of $7.8 billion (or $7.3 billion ex-DVA) was negatively impacted by weakness in Sales and Trading, yet net revenues are still higher YTD.
• Franchise strength evidenced through MS’ #1 U.S. Equities and #2 Global announced M&A positions with another strong Financial Advisory quarter.
• DBRS rates Morgan Stanley’s Issuer and Senior Debt at A (high) with a Stable trend.

DBRS, Inc. (DBRS) views Morgan Stanley’s (MS or the Company) 3Q15 results as challenged by the difficult operating environment in the quarter, which included high levels of volatility, rate uncertainty, market declines, postponed issuances, and overall lower client activity. As a result of weak Sales & Trading results, especially within Fixed Income & Commodities sales and trading, MS reported net income to common of $939 million on net revenues of $7.8 billion (or $7.3 billion ex-DVA). Despite significantly lower Sales and Trading revenues in 3Q, YTD total net revenues are up from 2014 reflecting MS’ strong 1H15. DBRS notes that MS’s globally diverse franchise, which includes #1 U.S. Equities and #2 Global announced M&A, remains supportive of the ratings. The continued progress on the Company’s long-term strategy was evident, as consistent wealth management results offset volatility within Institutional Securities.

The difficult operating environment resulted in Sales & Trading net revenues declining by 22% quarter-over-quarter (QoQ) and by 7% year-over-year (YoY) with Fixed Income & Commodities sales and trading having even steeper declines reflecting MS’ focus on credit and rates. Even with increased volatility, VaR was relatively stable during the quarter at $53 million. The difficult market conditions also contributed to lower underwriting revenues with the postponement of client issuances, both in the equity and fixed income businesses. Some rebound is anticipated as management expects these deals to happen over the next two quarters. Lastly, Financial Advisory remained robust. Importantly, MS reported that the overall investment banking pipeline has strengthened, which should help bolster future net revenues.

Wealth Management had positive net flows in the quarter and managed to report relatively stable total assets under management and supervision, despite lower market valuations, while also delivering a pre-tax margin of 23%. Net interest income was higher sequentially, as MS continues to grow Wealth Management loan balances, especially high quality residential real estate loans. Total net revenues in Investment Management were down materially QoQ, primarily due to the reversal of previously accrued carried interest in the MS Asia private equity business, which has been a strong contributor to revenues for over a decade.

Expenses remain well managed. So far in 2015, compensation and benefits were 45% of net revenues down from 48% YTD in 2014. The non-compensation ratio, however, was up to 29% from 27% YTD in 2014, due in part to litigation costs. This quarter included $320 million of legal expenses, which was mostly related to the settlement of credit default swap litigation.

The Company’s balance sheet remains strong with a fully-phased in Common Equity Tier 1 (CET1) ratio under the advanced approach of 12.4%, a fully phased-in supplementary leverage ratio of 5.5%, and a modestly higher global liquidity reserve at quarter-end.

DBRS rates Morgan Stanley’s Issuer and Senior Debt at A (high) with a Stable trend.

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