Fitch Affirms Morgan Stanley's Ratings at 'A/F1'; Outlook Stable

Fitch Ratings has affirmed Morgan Stanley's ratings including its Issuer Default Ratings (IDRs) at 'A/F1', support rating at '1', support rating floor (SRF) at 'A' and viability rating (VR) at 'a-'. The Rating Outlook is Stable. A full list of rating actions follows at the end of this rating action commentary.

The rating actions have been taken as part of a periodic review of the Global Trading and Universal Banks (GTUBs), which comprise 12 large and globally active banking groups. On balance, Fitch's outlook for the sector is stable. The 12 banks have continued to strengthen their balance sheets in 9M14. Capitalisation has improved materially over the past two years and liquidity remains sound. This strengthening balances continued pressure on earnings, particularly in securities businesses, and remaining material but unpredictable exposure to conduct and regulatory risks.

Fitch forecasts weak growth in the eurozone during 2015 while growth in the US and UK is expected to be somewhat stronger, which should help the GTUBs with a significant presence in these regions. Spikes in market volatility, most recently in October 2014, show that uncertainty remains over how expectations of rising interest rates in the US will affect financial markets. Our expectation is that rises in interest rates will be gradual and would follow improved prospects for the economy, which should help business volumes. Sharp and unexpected hikes in US interest rates would likely result in increased market volatility and, consequently, additional pressure on banks' earnings, although we believe that the GTUBs' risk appetite has declined.

Lower risk appetite should help the banks avoid material losses on trading positions but an adverse operating environment could result in a change of our outlook if earnings prospects suffer materially. For eurozone-focused banks, a prolonged deflationary scenario would put pressure on earnings and could result in a changed outlook.

KEY RATING DRIVERS - IDRs, SENIOR DEBT, SR and SRF

Morgan Stanley's Long- and Short-term IDRs, Support Rating (SR), Support Rating Floor (SRF) and senior debt ratings reflect Fitch's expectation that there remains an extremely high probability of support from the U.S. government (rated 'AAA'/Outlook Stable by Fitch) if required, and the Long-term IDR is at its SRF. This expectation reflects the U.S.'s extremely high ability to support its banks especially given its strong financial flexibility, though propensity is becoming less certain.

Specific to Morgan Stanley, Fitch's view of support likelihood is based mostly on its systemic importance in the U.S., global interconnectedness given its size and operations in global capital markets, growing deposit base and its position as a key provider of financial services to the U.S. economy. Morgan Stanley's IDRs and senior debt ratings benefit from support because Morgan Stanley's VR is below its SRF.

However, the momentum is gaining pace to resolve even the most complex banking groups without significantly disrupting the financial markets and without requiring state support. In Fitch's view, there is a clear intention to reduce support for G-SIFIs in the U.S., as demonstrated by the Dodd Frank Act (DFA) and progress regulators have made on implementing the Orderly Liquidation Authority (OLA). The FDIC has proposed its single point of entry (SPOE) strategy and further initiatives are demonstrating the U.S. government's progress to eliminate state support for U.S. banks going forward, which increases the likelihood of senior debt losses if its banks run afoul of solvency assessments. Despite the likely removal of support in the U.S., the Stable Outlook for Morgan Stanley's Long-term IDR reflects Fitch's view, that Morgan Stanley's fundamental credit profile is improving and that its viability rating is likely to improve over the next 6-9 months. Therefore the upward momentum in the VR offsets the likely removal of sovereign support in the U.S. which would result in Morgan Stanley's IDR and VR being equalized.

Morgan Stanley has announced that the sale of its physical commodities business to Rosneft will likely not close. Should this occur, this does not have ratings implications, it is a drag on the firm's capital and potentially for increased earnings volatility. Fitch will monitor the approach Morgan Stanley takes to divest this business.

RATING SENSITIVITIES - IDRS, SENIOR DEBT, SR AND SRF

The SR and SRF are sensitive to progress made in finalizing the SPOE strategy and any additional regulatory initiatives that may be imposed on the G-SIFIs, including debt thresholds at the holding company. Fitch's assessment of continuing support for U.S. G-SIFIs has to some extent relied upon the feasibility of OLA implementation rather than its enactment into law (when DFA passed). A key hurdle that remains is whether sufficient contingent capital exists at the holding company to recapitalize without requiring government assistance.

Fitch expects that the SPOE strategy and regulatory action to ensure sufficient contingent capital will be finalized in the near term, but regardless of its finalization Fitch believes that sufficient regulatory progress continues to be made over the ratings time horizon. Therefore, Fitch expects to revise Morgan Stanley's SR to '5' and its SRF to 'No Floor' likely during the first half of 2015.

It is unlikely that a revision of Morgan Stanley's SRF to 'No Floor' will lead to a downgrade of its Long-term IDR, despite the fact that Morgan Stanley's IDR is at its SRF, because Fitch expects that there will be upward momentum in Morgan Stanley's Viability Rating over the rating over the next year. Therefore, absent a material adverse change in market conditions or individual company profile, Morgan Stanley's IDRs are unlikely to change when the support rating floor is revised to 'No Floor'.

KEY RATING DRIVERS - VR

Morgan Stanley's VR of 'a-' continues to be supported by the company's solid liquidity position, improved risk management, and higher-than-average capital position. The VR also reflects Morgan Stanley's continued execution of its wealth management strategy based on its 100% ownership of Morgan Stanley Smith Barney including measured deployment of bank deposits into appropriate investments in lending products, improving margins and navigation of evolving regulatory challenges. The upward momentum in the VR reflects Fitch's expectation that Morgan Stanley will continue to effectively execute on its Wealth Management strategy, further reduce risk weighted assets, and improve ROEs to a level at or above its cost of capital. The VR remains constrained by wholesale funding risks, challenging industry prospects given the impact of new regulations and continued global economic uncertainty.

Overall, Morgan Stanley's performance (excluding one-time items) has improved as it continues to benefit from improved margins in the wealth management platform and investment banking revenues, which partially offset weaker fixed income and commodities net revenues. Furthermore, the company's results were not significantly impacted by litigation expenses and the slowdown in mortgage origination that affected it larger U.S. peers. Pre-tax operating margin for Wealth Management improved to 21% for the first nine months of 2014. Fitch believes that if the company can successfully execute on its strategy to deploy deposits into loans and securities with higher returns without assuming outsized risks, then it will be able to achieve a targeted pre-tax margin of 22% - 25% by 4Q'15.

Morgan Stanley's earnings are becoming more balanced as the company continues to expand its wealth management platform. This reduces the company's comparatively higher reliance on capital market operations in relationship to many other GTUBs, reflecting its focus on the institutional securities business. The greater stability derived from its wealth management platform and the measured growth of the bank contributes to the positive momentum in Morgan Stanley's VR. That said, Morgan Stanley's future earnings will continue to be less diverse than other larger universal banks.

Morgan Stanley's capital position is relatively strong and continues to improve. At 3Q'14, fully-phased in Tier 1 common ratio under Basel III advanced approach is estimated to be 12.7% (in line with the average of the U.S. GTUBs). Morgan Stanley reported that as of 3Q'14, the supplementary leverage ratio (SLR) for the holding company SLR was 4.9%, slightly below the 5% threshold. Fitch continues to believe that Morgan Stanley will be able to meet the SLR threshold prior to the required timeframe.

Liquidity continues to be maintained at conservative levels, which is viewed as appropriate given Morgan Stanley's wholesale funding profile. At 3Q'14, unencumbered highly liquid securities and cash was a solid $190 billion or 23% of total assets. Morgan Stanley estimated that is Basel III liquidity coverage ratio remains well in excess of 100%.

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. To reduce wholesale funding risk, Morgan Stanley has reduced its reliance on unsecured short-term to minimal levels with no reliance on commercial paper or 2a-7 funds as of 2Q'14. Morgan Stanley has a strong governance policy on secured funding, including maturity targets and limits set for each tier of collateral. Although deposits are increasing at the subsidiary bank, they remain a relatively moderate portion of the overall funding mix.

RATING SENSITIVITIES - IDRs, VR and SENIOR DEBT

Morgan Stanley's viability rating has a higher probability of being upgraded to 'a' from 'a-' upon further execution of its Wealth Management strategy, including measured deployment of bank deposits into appropriate investments in lending products, and improved returns on equity in excess of cost of capital. Successful navigation of evolving regulatory challenges including the Volcker Rule and Basel may also contribute to upward rating momentum as will maintenance of strong capital and liquidity levels.

Downward pressure on the VR could be driven by Morgan Stanley's inability to execute on its Wealth Management strategy, resulting in sustained operating weakness or returns on equity substantially below its cost of capital. Additional potential negative drivers could include an inability to successfully navigate evolving regulatory requirements such as the Volcker Rule or Basel, material losses, a significant increase in leverage and risk weighted assets, reduced capital ratios, deterioration in liquidity levels or outsized fines, settlements or other charges.

RATING DRIVERS AND SENSITIVITIES - SUBORDINATED DEBT and OTHER HYBRID SECURITIES

Subordinated debt and other hybrid capital issued by Morgan Stanley and by various issuing vehicles are all notched down from Morgan Stanley's VR in accordance with Fitch's assessment of each instrument's respective nonperformance and relative loss severity risk profiles. Subordinated debt and other hybrid capital ratings are primarily sensitive to any change in the VRs of Morgan Stanley.

RATING DRIVERS AND SENSITIVITIES - LONG- AND SHORT-TERM DEPOSIT RATINGS

Morgan Stanley's uninsured deposit ratings are rated one notch higher than the company's IDR and senior unsecured debt because U.S. uninsured deposits benefit from depositor preference. U.S. depositor preference gives deposit liabilities superior recovery prospects in the event of default. However, Morgan Stanley's uninsured deposits outside of the U.S. do not benefit from rating uplift because they do not typically benefit from the U.S. depositor preference unless the deposit is expressly payable at an office of the bank in the United States. Since Fitch cannot determine which foreign branch deposits may be dually payable, they do not get the rating uplift. The ratings of long and short-term deposits issued by Morgan Stanley and its subsidiaries are primarily sensitive to any change in Morgan Stanley's IDR.

RATING DRIVERS & SENSITIVITIES - HOLDING COMPANY AND OPERATING SUBSIDIARY

Fitch is now considering introducing a rating differential between the holding company and bank in the U.S. due to structural changes in the sector and the evolving regulatory landscape, as described in the special report 'U.S. Bank HoldCos & OpCos: Evolving Risk Profiles', dated March 27, 2014. This may result in a possible downgrade of Morgan Stanley's holding company rating, an upgrade of operating company ratings, or no changes to ratings if Fitch's views the long-term debt requirement assigned to Morgan Stanley as providing an insufficient amount of bail-in capital at the operating company level.

RATING DRIVERS AND SENSITIVITIES - SUBSIDIARY and AFFILIATED COMPANIES

The IDRs of Morgan Stanley's major rated operating subsidiaries are equalized with Morgan Stanley's IDR reflecting Fitch's view that these entities are core to Morgan Stanley's business strategy and financial profile.

Morgan Stanley is a leading global bank with three business segments: institutional securities, global wealth management, and asset management. In September 2008, Morgan Stanley converted to a bank holding company (BHC) regulated by the Federal Reserve. Morgan Stanley is currently the sixth largest bank by assets in the U.S. and designated as a G-SIFI by the Financial Stability Board.

Fitch affirms the following ratings:

Morgan Stanley

--Long-term IDR at 'A'; Stable Outlook;

--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 'BBB+';

--Preferred stock 'BB';

--Support at '1';

--Support floor at 'A'.

Morgan Stanley Bank N.A.

--Long-term IDR at 'A'; Stable Outlook;

--Long-term Deposits at 'A+';

--Short-term IDR at 'F1';

--Short-term deposits at 'F1';

--Support at '1'.

Morgan Stanley Australia Finance Ltd

--Long-term IDR at 'A'; Stable Outlook;

--Long-term senior debt at 'A';

--Short-term IDR at 'F1';

--Short-term debt at 'F1'.

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'.

Bank Morgan Stanley AG

--Long-term IDR at 'A'; Stable Outlook;

--Short-term IDR at 'F1';

--Support at '1'.

Morgan Stanley Secured Financing LLC

--Long-term senior debt at 'A';

--Short-term debt at 'F1'.

Morgan Stanley Capital Trust III-VIII

--Preferred stock at 'BB+'.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Related Research:

--'Global Financial Institutions Rating Criteria' (Jan. 31, 2014);

--'Securities Firms Criteria' (Jan. 31, 2014) ;

--'Assessing and Rating Bank Subordinated and Hybrid Securities (Jan. 31, 2014);

--'Rating FI Subsidiaries and Holding Companies' (Aug. 10, 2012);

--'The Evolving Dynamics of Support for Banks' (Sept. 11, 2013);

--'Bank Support: Likely Rating Paths' (Sept. 11, 2013);

--'Sovereign Support for Banks: Update On Position Outlined In 3Q13' (Dec. 10, 2013);

--'U.S. Bank HoldCos & OpCos: Evolving Risk Profiles' (March 2014).

Applicable Criteria and Related Research:

Global Financial Institutions Rating Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732397

Securities Firms Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732556

Assessing and Rating Bank Subordinated and Hybrid Securities Criteria

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732137

Rating FI Subsidiaries and Holding Companies

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=679209

The Evolving Dynamics of Support for Banks

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715000

Sovereign Support For Banks: Update on Position Outlined in 3Q13

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=726698

U.S. Bank HoldCos & OpCos: Evolving Risk Profiles

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=742096

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=935095

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