DBRS Ratings Unchanged After Q1 Earnings of Morgan Stanley – Senior at A (high)

DBRS has today commented on the Q1 2009 earnings of Morgan Stanley (the Company). DBRS ratings for the Company’s Issuer & Senior Debt are A (high) with a Negative trend. Morgan Stanley’s ratings are unchanged after the Company reported a net loss of $177 million for the quarter before payment of preferred dividends. Having changed its fiscal year end to December from November, the Company also reported a net loss of $1.3 billion for the month of December, a “stub period”, and restated prior quarters to conform to the new fiscal calendar.

While generating a moderate loss, Morgan Stanley demonstrated the strength of its franchise with the rebound in its revenues from large negative revenues in Q4 2008. If less disrupted market conditions continue to prevail in 2009, DBRS anticipates that the Company can sustain this improved revenue performance. The main driver of the loss was a $1.5 billion negative mark-to-market (MTM) impact on net revenues because of credit spread tightening on certain of the Company’s long-term debt. Without the effect of this MTM loss, Morgan Stanley would have posted income before taxes of approximately $650 million. DBRS views this MTM impact, whether positive or negative, as a macro hedge that helps to offset the impact of deteriorating market conditions and the Company’s own performance on revenues. Over the prior five quarters (Q4 2007 through Q4 2008), Morgan Stanley benefited from the positive MTM impact on this debt of credit spread widening; it could benefit from additional gains in the future, if its spreads were to widen.

The Company restated the quarterly information for the four prior quarters to conform to its new reporting on a calendar year basis. With this change, the stub period of December 2008 is included in Q4 2008 information and comparisons by the Company are made on this basis. For purposes of DBRS analysis, certain comparisons are made to the original (non-restated) quarterly data, as this information was the basis for analysis up to this point and restated data may be less comparable in certain cases.

Solid contributions to net revenues in Q1 2009 came from Institutional Securities (IS) and Global Wealth Management (GWM). Considering the difficult operating environment, DBRS views Morgan Stanley’s positive contribution to earnings from these core businesses as a demonstration of the power of the Company’s diversified franchise. As the IS segment is where most of the Company’s legacy assets, which have steadily been reduced, are held and where a large part of the prior quarter’s losses were taken, the resulting positive net revenues of $1.7 billion in the quarter is viewed by DBRS as a positive turnaround in this business.

Within IS, Fixed Income Sales & Trading reported net revenues of $1.3 billion, up from a loss of $1.2 billion in the quarter ended November 30, 2008, as commodities, interest rates and credit products were strong in the quarter. Equity Sales & Trading results were weaker, but still delivered positive net revenues of $877 million in the quarter, down 49% from the prior quarter and 75% from the Q1 2008 quarter, on a non-restated basis, due to lower levels of client activity in prime brokerage, derivatives and the cash businesses. The Company’s client-driven sales & trading revenues were approximately $2.9 billion in the quarter, excluding the impact of credit spread tightening, producing solid quarterly revenues at a sustainable run rate. Showing its resiliency, Investment Banking also contributed positively to improved IS net revenues, reporting $812 million for quarter, delivering an increase from $743 million in Q4 2008 though down about 17% from Q1 2008, on a non-restated basis. Despite a challenging market environment and lower activity levels, underwriting revenues were up on a linked-quarter basis by 87%.

GWM net revenues were $1.3 billion for the quarter, a slight increase versus the prior quarter but down 44% from the prior year’s quarter on a restated basis. The decrease was primarily attributed to two items: (1) gain on the sale of the Spanish wealth management business in Q1 2008 and (2) reduced asset management and transactional revenues, as client asset levels declined, market activity decreased, and underwriting revenues were lower.

Asset Management produced marginally positive net revenues in the quarter after negative revenues in Q4 2008, although they were still down 87% from Q1 2008 on a restated basis. The year-over-year decline was due to lower management and administrative fees and reduced assets under management (AUM). AUM declined with net customer outflows of $86.3 billion since Q1 2008, primarily in the Company’s money market and long-term fixed income funds. Continuing to drag on revenues is the Company’s Merchant Banking business, which reported negative net revenues of $319 million in the quarter driven by losses on principal investments in the real estate and private equity businesses.

The Negative trend reflects DBRS’s concern that the Company faces a difficult operating environment in which to adapt its diverse businesses, sustain its revenues and cope with the potential impact of adverse market movements on its now much reduced legacy positions. DBRS views positively the Company’s continued reduction of its legacy or “stalled” assets. The risk posed by these assets that remain on balance sheet is reduced as the Company is increasingly choosing to hold these assets. With solid results still being generated in some businesses, the diversity of Morgan Stanley’s business lines is an important factor supporting its overall revenues. Indications of a significant weakening in the Company’s franchise or its ability to generate sustainable earnings would very likely lead to a downgrade. While positive earnings would lessen the pressure on the ratings indicated by the Negative trend, the strength of the underlying trends would need to be well established and the overall operating environment would need to show significant improvement for the rating to revert to Stable.

In this environment, DBRS views positively Morgan Stanley’s continued efforts to bolster its capitalization by reducing its assets significantly (45% year-over-year to $626 billion), constraining its risk taking, substantially enhancing its liquidity and lowering its dividend. Morgan Stanley’s capital position benefited from the injection of TARP capital in Q4 2008. DBRS views the Company’s Tier 1 ratio of 16.4% under Basel I as providing a substantial cushion over the 6% regulatory minimum to be well capitalized.

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

The applicable methodology is Rating Securities Firms Operating in the United States, which can be found on our website under Methodologies.

This is a Corporate (Financial Institutions) rating.