Fitch Affirms Morgan Stanley's IDRs at 'AA-/F1+'; Outlook Negative

Business Wire,  July 9, 2008  

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NEW YORK -- Fitch Ratings has affirmed the 'AA-/F1+' long- and short-term Issuer Default Ratings (IDRs) of Morgan Stanley and its subsidiaries, along with all outstanding debt ratings. The rating affirmations follow a review of the investment banking industry. The Rating Outlook remains Negative. A complete list of ratings is detailed at the end of this press release.

Fitch revised Morgan Stanley's Outlook to Negative in December 2006 following the spin-off of Discover and a shift to assume greater market risk to enhance profitability. Profitability has been variable however due to weak proprietary trading results and write-downs in leveraged finance, commercial real estate and merchant bank investments. Second-quarter 2008 (2Q'08) earnings were disappointing, with write-downs totaling $1.6 billion. Profits would be marginally break-even absent one time events such as the gains on the sale of its Spanish wealth management franchise and the spin off of MSCI Barra, and excluding severance costs.

Fitch believes profitability for investment banks will continue to be challenged and highly variable over the next several quarters. Trading volumes are expected to contract as both institutional and retail investors become weary of continued price declines. Third quarter activity is typically the weakest of the year and this year may be materially weaker. While credit ratings are not driven by short term profitability, the ongoing variability has the potential to negatively impact capital. Expenses are being reduced gradually with industry ROEs materially below peak levels. Fitch is concerned that investor appetite for exposure to financial institutions may be at a saturation point thus any future capital raises may face significant market resistance.

Positively, Morgan Stanley has managed capital and liquidity well through this crisis. The firm raised $5.6 billion through a mandatory convertible issue in 1Q'08, ceased share repurchases and allocated treasury shares to employee compensation plans. This restored capital to pre-Discover levels and coupled with reductions in riskier assets, improved leverage and risk based capital ratios. Liquidity was enhanced through pre-funding debt issuance and remains sufficient to cover short term needs and meet business growth.

Recent earnings performance in proprietary trading, the elevation of risk just prior to this crisis, trader mismarks and the loss of market share in M&A league tables in the first half-2008 (1H'08) present profitability and risk management concerns. Fitch noted expressions of a more subdued risk appetite from management only in its most recent earnings call. Morgan Stanley's exposure to high risk assets such as leveraged loans, subprime mortgages, exposures to financial guarantors and commercial real estate is high, but considered manageable.

Management changes appear designed to reinvigorate risk management but, the firm needs to demonstrate an improved balance between profitability and risk taking. Fitch assumes proprietary trading performance was quite weak in 2Q'08 since spread revenues from prime brokerage were insufficient to bolster profits. Diversification benefits from its wealth and asset management businesses are also lacking as compared to other volatile trading cycles. Though profitability trends in these businesses were improving, a boost to mutual fund performance is needed and not currently expected to be forthcoming in this environment. Losses absorbed from the support of funds are also noted including a loss from the retention of Crescent REIT and on SIV investments held in its money market funds. Profit margins in its wealth management have gradually improved but not yet consistent with some peers.

Fitch expects the firm to prove its ability to manage risks with a more volatile business mix and maintain consistency in profits to remain in the AA rating category. Increases in risk appetite require additional capital and liquidity cushion if profitability remains weak. Financial flexibility has been retained although further capital raises could be cost prohibitive from a cash and reputation basis.

Fitch has affirmed the following ratings with a Negative Outlook:

Morgan Stanley

--Long-term IDR 'AA-';

--Short-term IDR 'F1+';

--Senior debt 'AA-';

--Subordinated 'A+';

--Preferred 'A+';

--Short-term Debt 'F1+'

--Individual 'B';

--Support '5';

--Support Floor 'NF'.

Morgan Stanley Bank

--Long-term IDR 'AA-';

--Long term deposits 'AA';

--Short-term IDR 'F1+';

--Short-term deposits 'F1+';

--Individual 'B';

--Support '1'.

Morgan Stanley Australia Finance Ltd.

--Long term IDR 'AA-';

--Senior debt 'AA-';

--Short-term IDR 'F1+';

--Short-term debt 'F1+'.

Morgan Stanley Canada Ltd.

--Short-term IDR 'F1+'.

--Short-term debt 'F1+'.

Bank Morgan Stanley AG

--Long term IDR 'AA-';

--Short-term IDR 'F1+';

--Individual 'B';

--Support '1'.

Morgan Stanley Capital Trust II - VIII

--Trust preferred 'A+'.

Morgan Stanley Capital Trust A, B, C