DBRS Ratings Unchanged After Q2 Earnings of Morgan Stanley – Senior at A (high)

DBRS has today commented on Q2 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 net income of $149 million for the quarter before payment of preferred dividends, following a marginal net loss of $177 million in Q1 2009 and net income of $1.1 billion in Q2 2008. With the Company’s conversion to a bank holding company (BHC) in Q4 2008, Morgan Stanley changed its fiscal year-end to correspond to the calendar year, resulting in quarterly restatements in 2008. In Q2 2009, Morgan Stanley repurchased capital issued under the U.S. Treasury Capital Purchase Program (TARP), resulting in a charge of $850 million. With this charge, other preferred dividends and related adjustments, Morgan Stanley reported a net loss applicable to common shareholders of $1.3 billion.

Bottom line results were affected by a variety of items. While underlying net revenue trends were generally favorable, overall net revenues were significantly reduced by a $2.3 billion negative debt valuation adjustment (DVA) reflecting the mark-to-market impact of credit spread tightening on certain of the Company’s long-term debt. The completion on May 31st of the joint venture with Citigroup (the JV) added $245 million in restructuring expenses, and contributed to increased compensation expense. In real estate investments, there were negative marks across the Company of $0.7 billion, while in the Lending businesses $0.6 billion of gains were balanced by $0.4 billion in hedge losses.

Although the bottom line was pressured, Morgan Stanley demonstrated the strength and diversity of its franchise with solid results in its Institutional Securities businesses. Resiliency was evident in the rebound in Investment Banking revenues driven by recovery in both debt and equity underwriting. Net revenues in Sales & Trading, excluding the DVA adjustment, showed a more modest improvement as constraints on risk taking and uneven performance across the businesses limited the rebound. Average VaR was virtually flat to Q1 2009. Based on DBRS’s calculations, Morgan Stanley’s “core” trading revenues returned to a more normalized run rate in the quarter. If less disrupted market conditions continue to prevail in the rest of 2009, DBRS anticipates that the Company can sustain this improved core revenue performance. In such an improving scenario, some additional DVA impact would be expected, although gains on legacy positions could provide some offset. DBRS views the DVA as a macro hedge against market disruption that resulted in cumulative gains of $10.6 billion from Q1 to Q3 2008, as spreads generally widened, followed by $9.3 billion of cumulative losses from Q4 2008 through Q2 2009, as spreads tightened.

Results in Global Wealth Management (GWM) were distorted by the inclusion of one month of operating results for Morgan Stanley Smith Barney (MSSB), of which the Company owns 51% and is fully consolidated. GWM generated net income of $76 million in Q2 2009 on net revenues of $1.9 billion, which were up 48% versus Q1 2009 and 13% compared to the prior year’s quarter, helped by the consolidation of MSSB. DBRS views successful integration of this JV as an important challenge for the Company as it seeks to leverage the scale and breadth of the combined businesses. Sustaining momentum while reducing expenses will be important indications of success for MSSB.

The Asset Management (AM) businesses continued to be a drag on earnings with its sixth quarterly net loss driven primarily by Merchant Banking. AM recorded a net loss of $108 million on net revenues of $575 million, in line with Q2 2008. While revenues were helped by gains from the disposition of securities issued by structured investment vehicles and higher principal investments revenues, the Merchant Banking business experienced mark-to-market losses related to real estate investments. Reflecting in part the downturn in the markets, assets under management declined to $361 billion versus $579 billion in Q2 2008, but asset outflows also contributed. In its core asset management businesses, Morgan Stanley is focused on improving investment management performance and other measures to enhance earnings from these businesses.

As reflected in the Negative trend, this quarter’s results continue to illustrate the risks facing the Company, given that its businesses are intertwined with the still fragile financial markets. DBRS views positively Morgan Stanley’s continued strengthening of its capitalization and reduction of legacy assets on the balance sheet. The Company bolstered its capital and funding in the quarter through equity raises and unguaranteed debt issuance, while reducing its assets and constraining its risk taking. DBRS views the Company’s Tier 1 ratio of 15.8%, after repayment of TARP, under Basel I as providing a substantial cushion over the 6% regulatory minimum to be well capitalized. In addition, the Company is benefiting from its more extensive relationship with MUFG. DBRS also views as appropriate the Company’s maintenance of its high level of liquidity.

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.