DBRS Ratings Unchanged After Q4 and Full Year 2009 Earnings of Morgan Stanley – Senior at A (high), Trend Negative

DBRS has today commented on Q4 2009 and full year 2009 earnings of Morgan Stanley (the Company). DBRS rates the Company’s Issuer & Senior Debt at A (high) with a Negative trend. The Company’s ratings are unchanged after it reported net income applicable to Morgan Stanley (net income), which is prior to payment of preferred dividends, of $617 million for the quarter following net income of $757 million in the prior quarter. The Company reported net income of $1.3 billion for the full year following a net loss of $246 million for FY 2008. The decline in earnings quarter-over-quarter reflected the more subdued market conditions in the current quarter; the improvement in earnings for FY 2009 versus the prior year can be attributed to the general stabilization of markets, combined with solid investment banking results and strength in customer flow businesses.

Underlying net revenue trends were indicative of the resiliency of the franchise, with full-year revenues doubling to $28.9 billion from just $12.9 billion in 2008, excluding the debt valuation adjustment (DVA). The latter captures the mark-to-market impact of credit spreads on certain of the Company’s long-term debt. Institutional Securities (IS), the major revenue driver, generated $18.3 billion in revenues, excluding the DVA, in FY 2009, of which over 75% was from sales & trading activities. As DBRS has consistently noted, trading is not a single business, but rather an activity conducted across a wide range of businesses and sectors, offering extensive products to diverse customer segments across many markets. The major contributor to the other 25% of IS revenues is the Company’s investment banking franchise, which delivered strong results throughout the year despite lower levels of market activity. In a major milestone, the Company completed on May 31st the joint venture with Citigroup (the JV), which contributed to the year-over-year revenue boost of 36% in Global Wealth Management (GWM) to $9.4 billion. Asset Management (AM) generated $1.3 billion in net revenues compared with just $463 million in FY 2008, driven by a 70% revenue increase in the Core business, which includes traditional, hedge funds and fund of funds asset management. Losses on principal investments within the Merchant Banking business continue to weigh on AM revenues.

On a quarterly basis, net revenues were $7.4 billion in Q4 2009 compared to negative net revenues of $7.0 billion in Q4 2008, excluding the DVA. On a linked quarter basis, revenues declined 20% from $9.3 billion with lower market activity. As noted, however, despite the generally weaker revenue performance, indicators of franchise strength were evident across the businesses. The strength of Morgan Stanley’s franchise is supported by 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.

Morgan Stanley views 2009 as a year of transition and 2010 as year of execution. DBRS expects successful execution would generate a sustained improvement in results. Besides recent management changes, the Company also accomplished some important strategic steps to strengthen its businesses. In its transition year, the Company expanded its GWM business through the JV, disposed of its Crescent real estate business and sold its retail asset management business. On the expense side, Morgan Stanley has controlled non-compensation expenses even with the additional charges in 2009 associated with the integration of the JV. Compensation is a key issue for financial institutions with large capital markets businesses and, in recognition of this, the Company has taken steps to restructure its compensation plans to include clawback provisions, performance stock units, and deferred compensation. Compensation expense to net revenues, excluding the DVA, was approximately 50% for FY 2009 down from over 80% for FY 2008.

Capital and liquidity remain strengths for the Company, in DBRS’s view. The Company’s strong capital is indicated by an estimated Tier 1 ratio of 15.4%. Morgan Stanley has begun to grow its assets, which increased by 14% to $772 billion year-over-year, while remaining highly liquid. DBRS views as appropriate the Company’s maintenance of its high level of liquidity, with a liquidity pool of $163 billion, or 21% of total assets, at the end of 2009. Reflecting significant low-risk assets, risk-weighted assets were approximately $300 billion, or just under 40% of total assets.

The Negative trend considers the challenges still faced by the Company in 2010, particularly execution risk and the still difficult environment. DBRS is looking for sustained improvement in quarterly performance to substantiate its views on the progress the Company is making across its business segments. DBRS notes that financial markets remain somewhat fragile and the economic recovery is still in its early stages.

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.