Fitch Affirms Morgan Stanley's Ratings at 'A/F1'
The rating actions have been taken in conjunction with Fitch's periodic review of the Global Trading and Universal Banks (GTUBs), which comprise 12 large and globally active banking groups. Fitch's outlook for the GTUBs is stable as we expect the groups' commercial banking and wealth and asset management businesses in 2016 to mitigate pressure on earnings from capital markets activities, particularly in fixed income trading.
As globally active universal banks, the 12 GTUBs are among the most affected by evolving regulation, which is bringing capital and resource constraints to some businesses. This means that business models are being adjusted. Specific changes and their timing vary by bank. In the medium term, we believe that the GTUBs with the strongest franchises in their core businesses, sound business models and clear strategies are best placed in this environment, and these company profiles are an important rating factor for many of the GTUBs.
KEY RATING DRIVERS
IDRs, VR AND SENIOR DEBT
Today's rating action and Stable Rating Outlook reflect MS's increasingly balanced business model across wealth management, investment management and capital markets activities. Fitch believes this will continue to help drive a more stable and sustainable source of net revenues and earnings for the company and eventually help overall returns on equity (ROE) to sustainably meet long-term targets.
Fitch considers the solid execution of the growth of the company's wealth management franchise to be supportive to the company's ratings. Over the last several years, MS has completed and integrated the acquisition of the Smith Barney businesses and begun to have a greater focus on lending out of this segment. These efforts have allowed the company to achieve a wealth management pre-tax margin of 23% in 3Q15, ahead of its stated targets of 22% - 25% by the end of 2015.
Importantly, MS continues to migrate the wealth management business away from more transactional sources for revenue and towards more recurring fee-based revenue. In 3Q15, this helped sustain the good pre-tax margin, as fee based revenues remained good while transactional revenue declined. Fitch believes this continued migration will enhance the durability of the segment's revenue.
As the company continues to increase the proportion of net interest income (NII), particularly related to the wealth management segment, this should further enhance the pre-tax margin, which while good remains below that of some larger peers. So far this year, MS has grown consumer loans by 23% and residential real estate loans by 25%.
These additional loan balances have helped MS to grow total firm NII by over $900 million, or 81.6%, so far this year relative to the same time frame in the year-ago period. As the company continues to grow loans, and eventually get a boost from higher interest rates at some point, Fitch would expect continued NII expansion over the next few years. This should help the company to reach its overall ROE targets.
While the wealth management strategy has remained relatively strong, performance in the Institutional Securities Group (ISG) has been more mixed. MS's advisory and equities franchises have remained strong, though these have been offset by challenging macroeconomic conditions in the company's Fixed Income and Commodities (FICC) group.
While the de-risking of the FICC business, as evidenced by continued risk-weighted asset reductions, is viewed positively from a creditor's perspective and is supportive of today's rating action, the earnings generated from this business remain challenged, and have weighed on overall company returns. While MS is focused on improving returns in this business through higher volumes of low-risk transactions as well as through efficiency initiatives, Fitch still expects this business to remain difficult over a near-to-medium term time horizon.
Further supporting today's action is the maintenance of higher than peer average capital ratios, as well as continued enhancements to the company's overall risk management. This is partially offset by more moderate deposit funding relative to some peer institutions. Fitch does acknowledge, however, that MS has substantially reduced its reliance on short-term unsecured funding.
SUBSIDIARIES AND AFFILIATED COMPANIES
Fitch notes that the VRs remain equalized between MS and its material operating subsidiaries. The common VR of MS and its operating companies reflects the correlated performance, or potential failure rate between the MS and these subsidiaries.
However, the Long-Term IDRs for the material U.S. operating entities are one notch above MS's Long-Term IDR to reflect Fitch's belief that the U.S. single point of entry (SPE) resolution regime, the likely implementation of total loss absorbing capacity (TLAC) requirements for U.S. global systemically important banks (G-SIBs), and the presence of substantial holding company debt reduces the default risk of domestic operating subsidiaries' senior liabilities relative to holding company senior debt.
Additionally, the 'F1' Short-Term IDRs of MS's bank subsidiaries are at the lower of two potential Short-Term IDRs which map to an 'A' Long-Term IDR on Fitch's rating scale, in order to reflect MS's greater reliance on wholesale funding than more retail focused banks. MS's and its non-bank operating companies Short-Term IDRs of 'F1' reflect Fitch's view that there is less surplus liquidity at these entities than at the bank, particularly given their greater reliance on the holding company for liquidity.
SUPPORT RATING AND SUPPORT RATING FLOOR
The Support Rating and Support Rating Floor for MS reflect Fitch's view that senior creditors cannot rely on receiving full extraordinary support from the sovereign in the event that MS becomes non-viable. In Fitch's view, implementation of the Dodd Frank Orderly Liquidation Authority legislation is now sufficiently progressed to provide a framework for resolving banks that is likely to require holding company senior creditors participating in losses, if necessary, instead of or ahead of the company receiving sovereign support.
Morgan Stanley Bank, N.A. (MSBNA) has a Support Rating of '1', which is reflective of Fitch's view of institutional support for the entity. MSBNA does not have a VR at this time, given Fitch's view of its more limited role within the group structure.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
Subordinated debt and other hybrid capital issued by MS are all notched down from the common VR in accordance with Fitch's assessment of each instrument's respective non-performance and relative loss severity risk profiles, which vary considerably. Subordinated debt issued by the operating companies is rated at the same level as subordinated debt issued by MS reflecting the potential for subordinated creditors in the operating companies to be exposed to loss ahead of senior creditors in MS. This is also supported by the FSB's proposal to have internal TLAC rank senior to regulatory capital at the operating company.
MS's subordinated debt is one notch down from MS's VR, its preferred stock is five notches down from the VR (which encompasses two notches for non-performance and three notches for loss severity), and its trust preferred stock is four notches down from the VR (encompassing two notches for non-performance and two notches for loss severity).
DEPOSIT RATINGS
U.S. deposit ratings are one notch higher than senior debt ratings reflecting the deposits' superior recovery prospects in case of default given depositor preference in the U.S. MS's international subsidiaries' deposit ratings are at the same level as their senior debt ratings because their preferential status is less clear and disclosure concerning dually payable deposits makes it difficult to determine if they are eligible for U.S. depositor preference.
RATING SENSITIVITIES
IDRs, VR AND SENIOR DEBT
Fitch considers MS's VR to be solidly situated at current levels. However, to the extent that the company is able to further improve the stability of its earnings profile and further reduce its reliance on wholesale funding while maintaining above peer-level capital ratios there could be some longer-term upside to the company's ratings.
While not expected, there remain several potential downside risks to ratings. These include any difficulty the company has in complying with the ever increasing and evolving regulatory requirements, any large and/or unforeseen losses from either litigation or a risk management failure, or the inability to generate consistent long-term ROEs in excess of their cost of capital.
MS's Long-Term IDR and senior debt are equalized with the VR at the holding company, and are notched up by one notch from the VR at the material operating companies. Thus ratings would be sensitive to any changes in MS's VR.
SUBSIDIARIES AND AFFILIATED COMPANIES
All U.S. bank subsidiaries carry a common VR, regardless of size, as U.S. banks are cross-guaranteed under the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA). Thus subsidiary ratings would be sensitive to any change in MS's VR would.
SUPPORT RATING AND SUPPORT RATING FLOOR
Support Ratings and Support Rating Floors would be sensitive to any change in Fitch's view of support. However, since Support Ratings and Support Rating Floors were downgraded in May 2015, there is unlikely to be any change to support ratings in the foreseeable future.
MSBNA's Institutional Support Rating of '1' is sensitive to any change in Fitch's views of potential institutional support for this entity.
SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
Subordinated debt and other hybrid ratings are primarily sensitive to any change in MS's VR.
DEPOSIT RATINGS
MS's deposit ratings are sensitive to any change in the IDR's which are sensitive to any change in the VRs. Thus, deposit ratings are ultimately sensitive to any change in the VR.
Fitch affirms the following:
Morgan Stanley
--Long-Term IDR at 'A'; Outlook Stable;
--Long-Term senior debt at 'A';
--Short-Term IDR at 'F1';
--Short-Term debt at 'F1';
--Commercial paper at 'F1';
--Market linked securities at 'Aemr';
--VR at 'a';
--Subordinated debt at 'A-';
--Preferred stock at 'BB+';
--Support at '5';
--Support floor at 'NF'.
Morgan Stanley Bank N.A.
--Long-Term IDR at 'A+'; Outlook Stable;
--Long-Term Deposits at 'AA-';
--Short-Term IDR at 'F1';
--Short-Term Deposits at 'F1+';
--Support at '1'.
Morgan Stanley Canada Ltd
--Short-Term IDR at 'F1';
--Short-Term debt at 'F1';
--Commercial paper at 'F1'.
Morgan Stanley International Finance SA
--Short-Term debt at 'F1'.
Morgan Stanley Secured Financing LLC
--Long-Term senior debt at 'A';
--Short-Term debt at 'F1'.
Morgan Stanley Capital Trust III, IV, V, VIII
--Preferred stock at 'BBB-'.
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