NEW YORK--(BUSINESS WIRE)--Morgan Stanley (rated 'A/F1') reported solid second quarter 2014 (2Q'14) results overall, despite weaker fixed income and commodities revenues (FIC), according to Fitch Ratings. More importantly from a rating perspective, however, continued improvement of the Wealth Management profit margin, growing client assets and increasing but measured loan growth all support potential medium term upward momentum to Morgan Stanley's 'a-' Viability Rating, in Fitch's opinion.
Morgan Stanley continues to take steps to attain a return on equity in excess of its cost of capital, including reducing risk weighted assets, controlling expenses and managing capital levels. These steps resulted in a reported return on average equity of 7.5% for 2Q'14, excluding debt-valuation adjustment (DVA) and a one-time $609 million tax benefit. Return on equity, while improved, remains challenged relative to certain peers and historical averages.
Morgan Stanley's overall profitability decreased from the prior quarter. As calculated by Fitch, pre-tax operating profits (excluding DVA impact) declined 14% to $1.9 billion at 2Q'14 from $2.2 billion at 1Q'14. Pre-tax operating return on assets (excluding DVA impact) was 0.09% as compared with 1.1% at 1Q'14. Expenses were unchanged from the prior quarter.
Wealth Management's pre-tax operating margin improved to 21% at 2Q'14 from 19% at 1Q'14. The higher margin was due to a $93 million increase in net revenues to $3.7 billion. Fitch continues to believe that Morgan Stanley's targeted pre-tax operating margin of 22%-25% in 4Q'15 is achievable if the company successfully executes on its strategy to deploy these deposits into higher-yielding securities and loans. Wealth Management client assets were a record $2 trillion.
Institutional net revenues (excluding DVA impact) declined 8% to $4.2 billion at 2Q'14. Morgan Stanley's FIC business was particularly challenged by a 39% quarter-over-quarter (QoQ) decrease in net revenues (excluding DVA impact), which was significantly weaker than peers. The decrease was driven by weaker performance in commodities following an unusually strong 1Q'14, with the most other product areas declining reflecting lower market volatility which affected client activity. Equity sales and trading net revenues of $1.8 billion (excluding DVA impact) were up 4% sequentially due to higher prime brokerage revenues benefiting from higher client balances and the European dividend season.
Investment banking net revenues increased 26% sequentially due to strength across all products with substantial growth in EMEA. Advisory revenues increased both on a QoQ basis and a year-over-year basis driven by higher M&A activity. Underwriting revenues were up 27% from 1Q'14 with equity underwriting increasing 55% reflecting a higher level of IPOs. The investment banking backlog remains strong and Morgan Stanley should continue to benefit from a higher level of activity.
Morgan Stanley has consistently maintained liquidity at conservative levels. Global liquidity reserve, including unencumbered liquid securities and cash, was a solid $192 billion (23% of total assets) at 2Q'14, down from $203 billion (24% of total assets) at 1Q'14. The decrease was primarily due to the deployment of excess cash from deposits into loans, which is consistent with the Wealth Management strategy. Value at Risk (VaR) was $48 million at 2Q'14 as compared with $50 million at 1Q'14, with reduced foreign exchange rate risk as the largest driver of the decline.
During 2Q'14, the firm reduced FIC risk-weighted-assets (RWA) to $192 billion from $199 billion at 1Q'14, further increasing the likelihood of achieving Morgan Stanley's target of $180 billion in fixed income and commodities RWA by year-end 2015.
Morgan Stanley estimated that its Tier I common ratio under the Basel III advanced approach was approximately 12.1% at 2Q'14, comfortably above the 8.5% minimum. The company estimated that its supplementary leverage ratio under the recent U.S. regulatory proposal for the bank exceeded 6%. The holding company supplementary leverage ratio under the new proposal was 4.6%, up from 4.2% at 1Q'14. Although below the 5% threshold, Fitch believes that Morgan Stanley will be able to meet the supplementary leverage minimums ahead of the required timeframe in 2018.
During 2Q'14, Morgan Stanley repurchased approximately $284 million shares under the recent CCAR authorization of $1 billion. Fitch believes that this level of share repurchase activity is manageable given current capital levels.
Additional information is available at 'www.fitchratings.com'.