September 28, 2017 / 9:15 PM / a year ago

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

(The following statement was released by the rating agency) CHICAGO, September 28 (Fitch) 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 Global Trading and Universal Banks (GTUBs). KEY RATING DRIVERS IDRs, VR, SENIOR DEBT, AND DERIVATIVE COUNTERPARTY Fitch's affirmation of MS's ratings and Stable Outlook reflect its strong global franchise, continued execution of its wealth management (WM) strategy, capital ratios near the top of the peer group, and solid funding and liquidity. These rating strengths continue to be offset by the company's exposure to capital markets businesses that are more volatile in nature, and its reliance on wholesale funding. Fitch views MS's balanced business model across capital markets, wealth management and investment management favorably. MS derives approximately 50% of its net revenue from wealth management and investment management activities, and the other half from investment banking, equity sales and trading, and fixed income, currency, and commodities (FICC). Fitch believes MS's business diversity contributes to more stable and sustainable earnings and should eventually help overall returns on equity (ROE) to sustainably meet 2017 targets of between 9%-11%. 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. Net interest income (NII) continues to become a larger proportion of MS's wealth management's revenue composition due in part to growth in lending as well as higher short-term interest rates over the course of the year. In second quarter 2017 (2Q17), NII comprised 24.3% of the wealth management segment's overall net revenue, up from 21.8% in the prior year period. MS is also increasing its use of technology in order to drive efficiencies and enhance customer-wallet share. To this end, MS has continued to execute on its "Project Streamline" efficiency initiative, which is targeting to reduce overall company expenses by $1 billion by the end of 2017. This initiative is focused on optimizing support services through the use of technology, actively managing compensation expenses and the absence of additional large litigation charges. The company has indicated that it remains on track to realize the targeted savings by year-end 2017. Fitch believes that the higher NII combined with expense control efforts helped buoy the wealth management segment's pre-tax margin to 25% in 2Q17 at the high end of the company's targeted range of between 23%-25%. Given the recent interest-rate hike in June 2017, Fitch would expect further NII growth and continued growth in the overall pre-tax profit margin for the WM business over the balance of the year. While the wealth management business has been growing, MS's capital markets activities still make up a significant portion of the company's revenue and earnings. Recent performance within MS's Institutional Securities Group (ISG) has improved but remains variable. Over the course of the year, MS has driven strong performance in the Investment Banking businesses partially offset by more tepid performance in the sales & trading businesses. However, Fitch notes that MS's Fixed Income net revenue decline in the quarter was lower than those experienced at other large banks. MS's fully phased-in Basel III Common Equity Tier 1 (CET1) ratio improved to 16.0% as of 2Q17, at the top of the peer-group. In addition, MS's Fitch Core Capital (FCC) ratio was a strong 16.8% at 2Q17. Fitch views capital levels as temporarily elevated and expects MS will look to return more capital to owners to the extent it is allowed through the CCAR review process each year. While the company's more wholesale-funded business model is a rating constraint relative to some peer institutions, Fitch acknowledges that MS has grown deposits, thereby substantially reducing its reliance on short-term unsecured funding, and also increasing its weighted average maturity of wholesale obligations. DERIVATIVE COUNTERPARTY RATING MS's Derivative Counterparty Rating (DCR) of 'A' is equalized with MS's IDR reflecting Fitch's view that derivative counterparties to MS will rank equally to other senior unsecured creditors. 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 MS's VR (with two notches for non-performance and two notches for loss severity). LONG- AND SHORT-TERM DEPOSIT RATINGS U.S. deposit ratings of Morgan Stanley Bank, N.A. (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. SUBSIDIARY AND AFFILIATED COMPANY The Long-Term IDR of MSBNA benefits from an institutional Support Rating of '1', which indicates Fitch's view that the propensity of the parent to provide capital support to the operating subsidiaries is extremely high. The institutional Support Rating of '1' suggests that MSBNA's Long-Term IDR would typically be equalized with that of the parent company; 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. RATING SENSITIVITIES VR, IDRs, SENIOR DEBT, AND DERIVATIVE COUNTERPARTY RATING Fitch considers MS's VR to be well situated at its current level. There could be some longer-term upside to ratings, although this would likely be limited to the 'A' rating category, reflecting the cyclicality of many of MS's capital markets businesses and its primary reliance on wholesale, confidence-sensitive funding sources. Should MS further improve the level and stability of its earnings such that overall annual ROEs are sustainably in excess of the company's targets of 9%-11%, 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 any large and/or unforeseen losses from either litigation or a risk management failure, particularly if permanent franchise damage is incurred as a result. Fitch notes that MS's Long-Term IDR, senior debt, and DCR are equalized with the VR at the holding company. Thus MS's IDR, senior debt ratings and DCR would be sensitive to any changes in MS's VR. DERIVATIVE COUNTERPARTY RATING DCRs are primarily sensitive to changes in the respective issuers' Long-Term IDRs. In addition, they could be upgraded to one-notch above the IDR if a change in legislation (for example as recently proposed in the EU) creates legal preference for derivatives over certain other senior obligations and, in Fitch's view, the volume of all legally subordinated obligations provides a substantial enough buffer to protect derivative counterparties from default in a resolution scenario. SUBORDINATED DEBT AND OTHER HYBRID SECURITIES Subordinated debt and other hybrid ratings are primarily sensitive to any change in MS's VR and secondarily to a change in Fitch's recovery expectations for such instruments. LONG- AND SHORT-TERM 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. SUBSIDIARY AND AFFILIATED COMPANY 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 Support Ratings and Support Rating Floors 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 these 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. Fitch affirms the following: Morgan Stanley --Long-Term IDR at 'A'; Outlook Stable; --Long-term senior debt at 'A'; --Derivative Counterparty Rating at 'A(dcr)'; --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'. 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