DBRS Confirms Ratings of Morgan Stanley Following Q3 Earnings – Senior at A (high); Trend Remains Negative

DBRS has today confirmed the ratings for Morgan Stanley (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 Negative and the trend on all short-term ratings remains Stable. The rating confirmation reflects the Company’s strong fundamentals that are evident in its improved quarterly performance. The Company reported net earnings applicable to Morgan Stanley of $757 million in Q3 2009, which is before preferred dividends. This follows net earnings of $149 million in Q2 2009 and a marginal net loss of $177 million in Q1 2009. DBRS notes that despite the loss in the first quarter, Morgan Stanley remains profitable year-to-date with earnings on an upward trajectory.

Underpinning the current ratings level are the strength of Morgan Stanley’s franchise, its core earnings resiliency, bolstered liquidity, reinforced financial profile and enhanced risk management. The Company has sustained its leading role in the critical Investment Banking segment, particularly in the highly visible advisory businesses. In its Equities sales and trading businesses, the Company’s franchise has remained strong with revenues rebounding with the recovery in market activity. In Fixed Income, key business lines, such as foreign exchange and rate products, demonstrated their strong capabilities throughout the crisis, but the overall rebound in this segment in the first half of 2009 was muted by a constrained risk appetite and weak performance in some businesses. With recent management changes and enhanced risk management processes now in place, results should show further improvement. Morgan Stanley’s Global Wealth Management business has become a more important, well-positioned component of the franchise. With the MSSB joint venture (the JV), it has become the largest retail brokerage firm by client assets. The Company is also taking important steps in restructuring its asset management businesses by focusing on those businesses where its franchise can add the most value and shedding those businesses where it lacked the scale to be a top competitor. The Company’s strong capital and solid liquidity are indicated by an estimated Tier 1 ratio of 15.3% and excess liquidity of $153 billion in Q3 2009.

The Negative trend considers the Company’s slow return to profitability, recovering revenue trends, the challenges in the integration of the JV, and the asset management segment’s weak performance. DBRS will look for sustained improvement in quarterly performance to substantiate its views on the progress the Company is making. DBRS notes that the Company’s risk profile has improved, as it has significantly reduced exposure to illiquid assets, but remaining exposures do leave Morgan Stanley open to additional write downs, especially in commercial real estate, if the environment deteriorates. Despite market indicators returning to more normal conditions, the economy remains weak and deteriorating credit metrics are keeping the banking sector and various segments of the markets under stress. Even though Morgan Stanley’s position has considerably strengthened from a year ago, the Company, like other participants in the capital markets, remains exposed to the potential recurrence of financial turmoil that could again lead to disrupted activities, reduced revenues and diminished investor confidence, which could particularly affect the Company as a largely wholesale funded institution.

Indicative of the Company’s franchise strength, revenue trajectories in its Institutional Securities (IS) and Global Wealth Management (GWM) businesses showed improvement during the quarter. Underlying net revenue trends were generally favorable, though overall net revenues of $8.7 billion were reduced by a $900 million negative debt valuation adjustment (DVA) due to the mark-to-market impact of credit spread tightening on certain of the Company’s long-term debt. So far in 2009, the Company has recognized losses totaling close to $5 billion from DVA adjustments that reverses cumulative gains of over $9 billion in 2007 and 2008. DBRS anticipates additional spread tightening, which reflects positively on investor perceptions and reduces the Company’s funding costs, but impacts bottom line results. Excluding the DVA adjustment, other write downs and one-offs, DBRS calculates Morgan Stanley’s core net revenues of $9.2 billion improved 22% compared to Q2 2009 and 30% relative to Q3 2008. Revenues in IS were boosted by strong underwriting revenues and solid performance in interest rate, credit and currency products. GWM revenues were strengthened with a full quarter of consolidated results for the JV.

DBRS views positively the restructuring of the Company’s investment management unit, including the sale of its retail asset management businesses, to focus on the institutional client base. The sale is expected to close in the middle of next year and Morgan Stanley will book the gain on the transaction at that time. DBRS notes that the Asset Management (AM) segment has been a drag on earnings over the past seven quarters and the restructuring will allow Morgan Stanley to focus on its more profitable institutional clients. The Merchant Banking business, which remains within AM, experienced mark-to-market losses related to real estate investments of $400 million in the quarter. Assets under management declined to $386 billion versus $483 billion in the year-ago quarter, primarily due to net customer outflows. In its core asset management businesses, which include traditional, hedge funds and fund of funds asset management, Morgan Stanley is focused on improving investment management performance and other measures to enhance earnings from these businesses.

Notes:
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.