Fitch Affirms Morgan Stanley's Long-Term IDR at 'A'; Outlook Stable

NEW YORK--()--Fitch Ratings has affirmed Morgan Stanley's (MS) Long-Term and Short-Term Issuer Default Ratings (IDRs) at 'A/F1', and its Viability Rating (VR) at 'a'. The Rating Outlook is Stable.

The rating affirmations have been taken in conjunction with Fitch's periodic review of the of the Global Trading and Universal Banks (GTUBs).

KEY RATING DRIVERS

IDRs, Viability Rating AND SENIOR DEBT

Fitch's affirmation of MS's ratings and maintenance of a Stable Outlook reflect its strong global franchise, higher capital ratios, significantly improved funding and liquidity positions, and continued execution of its wealth management strategy, offset by exposure to market-sensitive businesses, reliance on wholesale funding and recent earnings pressure.

Fitch views favorably MS's more balanced business model across wealth management, investment management and capital markets activities. In 2015, MS derived nearly 50% of its net revenue from a combination of wealth management and investment management, and the other half from a combination of investment banking, equity sales and trading, and fixed income, currency, and commodities (FICC).

Fitch believes this business diversification 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. We consider the solid execution of the growth of MS's wealth management franchise to be supportive of the company's ratings. MS is increasing its use of technology in order to drive efficiencies and enhance customer-wallet share and increasing its focus on lending out of this segment.

These efforts allowed the company to achieve a wealth management pre-tax margin of 21% in first-quarter 2016 (1Q16), in line with its stated targets. To the extent that the company is successful in harnessing technology to drive its business and in building out its lending portfolio, Fitch believes there is further upside to the wealth management pre-tax margin over a medium-term time horizon.

Additionally, Fitch notes that as MS continues to migrate the wealth management business away from more transactional sources of revenue and towards more recurring fee-based revenue, this should help the durability of the segment's overall revenue profile.

While the wealth management business has been growing, MS's capital markets activities still comprise a significant portion of the company's earnings. Recent performance within MS's Institutional Securities Group (ISG) has been more challenging. MS's advisory and equities franchises remain strong, although they have not been immune from the challenging market conditions over the last several months, including a dearth of initial public offerings (IPOs).

Even more challenging, however, has been the performance of the company's FICC business which has weighed down the company's overall performance.

Fitch views the de-risking of MS's FICC business over the last few years as a positive from a creditor's perspective in that it reduces both volatility of results and the potential for unexpected losses. However, it also makes generating acceptable returns from these businesses more challenging.

In the past year, MS has changed the leadership of the FICC business and also significantly reduced costs and headcount in this segment. Similar to some of its other businesses, MS is focused on utilizing technology in this business to drive higher volumes of low-risk transactions. To the extent that management is successful in these efforts, it will drive more efficient balance sheet utilization, as well as create a leaner operating model that could potentially lead the business closer to its 10% return on equity target.

While this potential earnings improvement would be viewed positively, we note that the execution of this strategy will likely occur over a medium- to longer-term time horizon and that performance is likely to remain challenging at least over the balance of the year.

With the sale of MS's physical oil business in 4Q15 as well as the continued reduction of risk-weighted assets (RWA) in the FICC business, MS's fully phased-in Basel III Common Equity Tier 1 (CET1) ratio improved to 14.6% as of 1Q16, well above peer-group averages.

Fitch notes that this improvement in the company's capital ratios helps limit potential downsides to ratings from unexpected events or losses, although higher capital ratios are partially offset by the company's more wholesale-funded business model relative to some peer institutions.

That said, Fitch does acknowledge that MS has grown deposits, substantially reduced its reliance on short-term unsecured funding, and increased its weighted average maturity of wholesale obligations.

SUBSIDIARIES AND AFFILIATED COMPANIES

The Long-Term IDR of Morgan Stanley Bank, N.A. (MSBNA) benefits from an institutional Support Rating of '1', which indicates Fitch's view of the propensity of the parent to provide capital support to the operating subsidiaries is extremely high.

As such, MSBNA's Long-Term IDR would typically be equalized with that of the parent company due to the institutional Support Rating noted above; however, MSBNA's ratings also receive an additional one-notch uplift above MS's Long-Term IDR to reflect Fitch's belief that the U.S. single point of entry (SPOE) 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 reduce the default risk of these domestic operating subsidiaries' senior liabilities relative to holding company senior debt.

Additionally, MSBNA's 'F1' Short-Term IDR is 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 the company's greater reliance on wholesale funding than more retail-focused banks. MS 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 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 has now sufficiently progressed to provide a framework for resolving banks that is likely to require holding company senior creditors to participate in losses, if necessary, instead of or ahead of the company receiving sovereign support.

As previously noted, MSBNA has a Support Rating of '1', which reflects Fitch's view of an extremely high probability 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 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. MS's subordinated debt is rated one notch below MS's VR, its preferred stock is rated five notches below (which encompasses two notches for non-performance and three notches for loss severity), and its trust preferred stock is rated four notches below (encompassing two notches for non-performance and two notches for loss severity).

DEPOSIT RATINGS

U.S. deposit ratings of MSBNA are one-notch higher than senior debt ratings of MSBNA reflecting the deposits' superior recovery prospects in case of default given depositor preference in the U.S.

RATING SENSITIVITIES

IDRs, VR AND SENIOR DEBT

Fitch considers MS's VR to be solidly situated at current levels. There could be modest longer-term upside to ratings, although this would likely be limited to the 'A' rating category. Should MS be able to further improve the level and stability of its earnings such that returns on equity (ROEs) are sustainably in excess of 10%-12%, while further reducing its reliance on wholesale funding and maintaining strong capital ratios, this could lead to some modest upside to the ratings.

Potential downside risks to ratings include an inability to comply with the ever-increasing and evolving regulatory requirements as well as any large and/or unforeseen losses from either litigation or a risk management failure, particularly if permanent franchise damage is incurred as a result.

In addition, and while not expected, to the extent that the company's operating performance as measured by ROE remains challenged and consistently below peers, its historical averages, and Fitch's estimate of the company's cost of equity noted above, this could ultimately lead to negative ratings pressure over a longer-term time horizon.

Fitch notes that MS's Long-Term IDR and senior debt are equalized with the VR at the holding company. Thus MS's IDR and senior debt ratings would be sensitive to any changes in MS's VR.

SUBSIDIARIES AND AFFILIATED COMPANIES

As noted, MSBNA carries an institutional support rating of '1', as Fitch believes support from the parent would be extremely highly likely. Thus MSBNA's rating would be sensitive to any change in Fitch's view of institutional support as well as any change to the VR of the parent company.

Additionally, MSBNA's IDR is rated one-notch higher than the parent holding company's IDR because the bank subsidiary benefits from the structural subordination of holding company TLAC, which effectively supports senior operating liabilities of the bank subsidiary. Any change in Fitch's view on the structural subordination of TLAC with respect to MSBNA could also result in a change in MSBNA's IDR.

SUPPORT RATING AND SUPPORT RATING FLOOR

SRs and SRFs would be sensitive to any change in Fitch's view of support. However, since these two were downgraded to '5' and 'No Floor', respectively, in May 2015, there is unlikely to be any change to Support Ratings in the foreseeable future.

MSBNA's Institutional SR of '1' is sensitive to any change in Fitch's views of potential institutional support for this entity from the parent company.

SUBORDINATED DEBT AND OTHER HYBRID SECURITIES

Subordinated debt and other hybrid ratings are primarily sensitive to any change in MS's VR.

DEPOSIT RATINGS

MSBNA's deposit ratings are sensitive to any change in the entity's IDR, which is sensitive to any change in the VR of the parent company given the institutional SR of '1'. Thus, deposit ratings are ultimately sensitive to any change in MS's VR or Fitch's view of institutional support for that entity.

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-'.

Additional information is available on www.fitchratings.com

Applicable Criteria

Global Bank Rating Criteria (pub. 20 Mar 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=863501

Global Non-Bank Financial Institutions Rating Criteria (pub. 28 Apr 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=865351

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Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1006056

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https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Justin Fuller, CFA
Senior Director
+1-312-368-2057
Fitch Ratings, Inc.
70 W. Madison, Street
Chicago, IL 60602
or
Secondary Analyst
Nathan Flanders
Managing Director
+1-212-908-0827
or
Committee Chairperson
Christopher Wolfe
Managing Director
+1-212-908-0771
or
Media Relations:
Hannah James, New York, + 1 646-582-4947
Email: hannah.james@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Justin Fuller, CFA
Senior Director
+1-312-368-2057
Fitch Ratings, Inc.
70 W. Madison, Street
Chicago, IL 60602
or
Secondary Analyst
Nathan Flanders
Managing Director
+1-212-908-0827
or
Committee Chairperson
Christopher Wolfe
Managing Director
+1-212-908-0771
or
Media Relations:
Hannah James, New York, + 1 646-582-4947
Email: hannah.james@fitchratings.com