LONDON--(BUSINESS WIRE)--Fitch Ratings has upgraded Morgan Stanley's (MS) Viability Rating (VR) to 'a' from 'a-'. At the same time, Fitch has affirmed MS's Long-Term and Short-Term Issuer Default Ratings (IDR) at 'A'/'F1', respectively. The Outlooks for the Long-Term IDRs are Stable.
MS's Long-Term IDR is now driven by its VR. The upgrade of MS's operating subsidiaries' IDRs to one notch above their VRs reflects the expected implementation of total loss absorbing capital (TLAC) requirements for U.S. Global Systemically Important Banks (G-SIBs) and the presence of a substantial debt buffer in the holding company.
A full list of rating actions follows at the end of this rating action commentary.
The rating actions are in conjunction with Fitch's review of sovereign support for banks globally, which the agency announced in March 2014. In line with its expectations announced in March last year and communicated regularly since then, Fitch believes legislative, regulatory and policy initiatives have substantially reduced the likelihood of sovereign support for U.S., Swiss and European Union commercial banks. At the same time, Fitch has taken into account progress with the U.S. single point of entry (SPE) resolution regime and TLAC implementation for U.S. G-SIBs.
Fitch believes that, in line with our Support Rating (SR) definition of '5', extraordinary external support while possible can no longer be relied upon for MS or its subsidiaries. We have, therefore, downgraded their Support Ratings (SR) to '5' from '1' and revised their Support Rating Floors (SRF) to 'No Floor' from 'A'.
The ratings actions are also part of a periodic portfolio review of the Global Trading and Universal Banks (GTUBs), which comprise 12 large and globally active banking groups. A strong rebound in earnings from securities businesses in 1Q15 is a reminder of the upside potential banks with leading market shares can enjoy. However, regulatory headwinds remain strong, with ever higher capital requirements, costs of continuous infrastructure upgrades and a focus on conduct risks.
As capital and leverage requirements evolve, GTUBs are reviewing the balance of their securities operations with other businesses and adapting their business models to provide the most capital efficient platforms for the future. We expect the GTUBs' other core businesses, including retail and corporate banking, wealth and asset management, to perform well as economic growth, which we expect to be strongest in the U.S. and UK, will underpin revenue. However, pressure on revenue generation in a low-interest environment is likely to persist, particularly in Europe, but low loan impairment charges in domestic markets should help operating profitability.
KEY RATING DRIVERS - IDRs, VR AND SENIOR DEBT
The upgrade of MS's VR to 'a' from 'a-' reflects MS's continued successful execution on its business model evolution towards a balance between wealth management, capital markets and investment management activities, resulting in improved earnings diversification and stability.
Furthermore, Fitch notes that within MS's wealth management segment, management has been successful in migrating the business away from more transactional commission based revenue and towards recurring fee-based revenue, which Fitch believes adds some additional durability and balance to both the segment and the company's earnings profile.
What's more, while MS's wealth management pre-tax margin is below that of some larger peers -- which routinely have pre-tax margins of approximately 30% -- Fitch believes that MS's wealth management pre-tax margin has the potential to further improve to the extent that MS is able to further improve its net interest income (NII) from banking activities attributable to the wealth management business. The company achieved a wealth management pre-tax margin of 22% in 1Q15, which is ahead of its stated targets of 22% - 25% by the end of 2015.
Further supporting the upgrade of the VR is continued reductions in risk-weighted assets (RWA), the maintenance of higher than peer average capital ratios, and ongoing enhancements to the company's overall risk management.
Further upward momentum in MS's VR primarily remains constrained by MS's wholesale funding risks. On balance, Fitch believes that Morgan Stanley is more vulnerable to funding and rollover risks than a number of GTUB peers as it is primarily wholesale funded.
While Fitch would note that MS has reduced its reliance on unsecured Short-Term funding to minimal levels with no reliance on commercial paper or 2a-7 funds, deposit funding remains a relatively moderate portion of the company's overall funding mix.
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 failure rate between the MS and these subsidiaries. Fitch takes a group view on the credit profile from a failure perspective, while the IDR reflects each entity's non-performance (default) risk on senior debt. Fitch believes that the likelihood of failure is roughly equivalent, while the default risk given at the operating company would be lower given TLAC. 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).
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. SPE resolution regime, the likely implementation of TLAC requirements for U.S. 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. In our view these buffers would provide substantial protection to senior unsecured obligations in the domestic operating entities in the event of group resolution, as they could be used to absorb losses and recapitalize operating companies. Therefore, substantial holding company debt reduces the likelihood of default on operating company senior obligations. As at end-2014, MS had hybrid and senior debt as a percent of risk-weighted assets (RWA) of above 20%, more than its Pillar 1 capital requirement.
The 'F1' Short-Term IDRs of MS's bank subsidiaries are at the lower of two potential Short-Term IDRs mapping to an 'A' Long-Term IDR on Fitch's rating scale to reflect a greater reliance on wholesale funding than more retail focused banks. MS's and its non-bank operating companies Short-Term IDRs at '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.
RATING SENSITIVITIES - IDRs, VR AND SENIOR DEBT
After today's upgrade, 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 all 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 returns on equity in excess of their cost of capital.
MS' Long-Term IDR and senior debt are equalized with the VR at the holding company, and notched up by one notch from the VR at the material operating companies. Thus ratings would be sensitive to any changes in MS' VR.
KEY RATING DRIVERS AND SENSITIVITIES - SUPPORT RATING AND SUPPORT RATING FLOOR
The SR and SRF reflect Fitch's view that senior creditors can no longer 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.
Any upward revision to the SR and SRF would be contingent on a positive change in the U.S.'s propensity to support its banks. While not impossible, this is highly unlikely in Fitch's view.
KEY RATING DRIVERS AND SENSITIVITIES - 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. Their ratings are primarily sensitive to any change in the common VR. They have, therefore, been upgraded due to the upgrade of the common VR.
KEY RATING DRIVERS AND SENSITIVITIES - DEPOSIT RATINGS
The upgrade of Morgan Stanley Bank, N.A.'s (MSB) deposit ratings is based on the upgrade of its IDRs. 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.
The rating actions are as follows:
Morgan Stanley
--Long-Term IDR affirmed at 'A'; Outlook Stable;
--Long-Term senior debt affirmed at 'A';
--Short-Term IDR affirmed at 'F1';
--Short-Term debt affirmed at 'F1';
--Commercial paper affirmed at 'F1';
--Market linked securities affirmed at 'Aemr';
--VR upgraded to 'a' from 'a-';
--Subordinated debt upgraded to 'A-' from 'BBB+';
--Preferred stock upgraded to 'BB+' from 'BB';
--Support downgraded to '5' from '1';
--Support floor revised to 'NF' from 'A'.
Morgan Stanley Bank N.A.
--Long-Term IDR upgraded to 'A+' from 'A'; Outlook Stable;
--Long-Term Deposits upgraded to 'AA-' from 'A+';
--Short-Term IDR affirmed at 'F1';
--Short-Term Deposits upgraded to 'F1+' from 'F1';
--Support affirmed at '1'.
Morgan Stanley Canada Ltd
--Short-Term IDR affirmed at 'F1';
--Short-Term debt affirmed at 'F1';
--Commercial paper affirmed at 'F1'.
Morgan Stanley International Finance SA
--Short-Term debt affirmed at 'F1'.
Morgan Stanley Secured Financing LLC
--Long-Term senior debt affirmed at 'A';
--Short-Term debt affirmed at 'F1'.
Morgan Stanley Capital Trust III-VIII
--Preferred stock upgraded to 'BBB-' from 'BB+'.
Fitch has affirmed and withdrawn the following ratings because they are no longer considered by Fitch to be relevant for our rating coverage, because as part of MS's group restructuring the below entities have transferred almost all of their business to other group entities.
Morgan Stanley Australia Finance Ltd
--Long-Term IDR at 'A'; Stable Outlook;
--Short-Term IDR at 'F1';
--Short-Term debt at 'F1'
--Long-Term senior debt at 'A';
Bank Morgan Stanley AG
--Long-Term IDR at 'A'; Stable Outlook;
--Short-Term IDR at 'F1';
--Support at '1'.
Additional information is available at 'www.fitchratings.com.'
In addition to the source(s) of information identified in Fitch's Master Criteria, these actions were additionally informed by information provided by the companies.
Applicable Criteria and Related Research:
--'Global Financial Institutions Rating Criteria' (March 20, 2015);
--'Global Non-Bank Financial Institutions Rating Criteria' (April 2015).
Applicable Criteria and Related Research:
Global Financial Institutions Rating Criteria - Effective from 31 January 2014 to 20 March 2015
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732397
Global Non-Bank Financial Institutions Rating Criteria
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=865351
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=984984
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