by
Justin McCarthy | Jan 21, 2014
Key points
- Morgan Stanley’s results improved on an underlying basis but a cloud over future legal expenses and the potential for share-buy backs or increased dividends is a negative for debt holders.
- Morgan Stanley bond spreads have contracted and we recommend taking profits and looking for value elsewhere. The new Bendigo and Adelaide subordinated bond is viewed as an attractive alternative.
Morgan Stanley reported their 4Q13 results last week with a lower than expected bottom line profit of US$181m due to a significant increase in legal expenses. The company took a US$1.2bn provision in 4Q13 “litigation and investigations related to residential mortgage-backed securities and the credit crisis.”
In relation to the legal and litigation provisions, James Gorman, Morgan Stanley’s chief executive said, “we are continuing to address many of the legal issues from the financial crisis.” However, the company did not reveal specifically what the US$1.2bn in legal costs will be used to cover.
However, underlying profit remained solid if the legal expenses and impact of debt valuation adjustments are added back.
Revenue increased from US$7.0bn in 4Q12 to US$7.8bn in 4Q13, mainly as a result of strong results in the Wealth Management and Equities divisions.
On the flipside, the bond trading division saw a 14.4% drop in revenue which was in-line with its US bank/investment bank peers. Activity in the US bond market weakened in the 4Q13 as investors waited for the US Federal Reserve to start scaling back its bond-buying programme, and longer term yields started rising.
The company also updated their strategic plan which is likely to see a modest increase in dividends and share buy-backs in 2014, with forecasts of US$2.5bn to US$5.0bn in stock repurchases. While Morgan Stanley capital ratios are estimated to be around 2% in excess of Basel III requirements, any reduction in capital via increased dividends or share buybacks reduces the buffer for debt holders and is viewed as a negative for the credit.
Conclusion
As previously written, we believe the value in senior debt of US investment banks, including Morgan Stanley, is no longer present. While the Bank has continued to improve, the prospect of legal settlements, dividend increases and share buybacks will increase credit risk.
As the following charts (Figure 1 - Yield to maturity and Figure 2 - Trading margin) for the existing AUD Morgan Stanley fixed rate senior debt issues demonstrate, the bonds have rallied strongly over the past 18 to24 months. We view this as a good opportunity to take profits for those that still maintain a holding.The new Bendigo and Adelaide subordinated bond is viewed as an attractive alternative.
Figure 1
Figure 2
Prices and yields are a guide only and subject to market availability. FIIG does not make a market in these securities.