Morgan Stanley's
(
MS
) plans of moving a large portion of its $52 trillion derivatives
portfolio to its subsidiary bank have been put on hold by the U.S.
Federal Reserve. The company's decision to shift this huge amount
comes in the wake of a possible credit downgrade by credit rating
agency Moody's Investor Service, a wing of
Moody's Corp.
(
MCO
).
The Fed has not ruled out Morgan Stanley's appeal to transfer
its derivative portfolio. However, under the Dodd-Frank financial
reforms, the Fed needs to formally discuss the matter with another
regulatory authority, the Federal Deposit Insurance Corporation
(FDIC). That is why the announcement of the final decision is being
delayed.
The Fed is entrusted with safeguarding the stability of the
entire financial system, whereas FDIC's objective is to safeguard
banks' deposits. Both regulatory bodies differ on their objectives.
As a result, the issue has become a bit complicated.
From Morgan Stanley's point of view, this is a strategic action
to reaffirm the trading partners' confidence in its financial
strength. Moreover, the growth in earnings is anticipated,
propelled by lower funding costs if the derivatives are moved to
Morgan Stanley's bank. The bank retains a long-term credit rating
of A1, whereas Morgan Stanley as a whole retains A2 rating by
Moody's.
Moody's is anticipated to downgrade the entire banking sector,
which is bound to affect nearly 17 global and 114 European
financial institutions. The decision to downgrade reflects the
increasing impact of European debt crisis across the global
financial markets.
Morgan Stanley's ratings could further fall three notches to
Baa2. Several other banks like
JPMorgan Chase & Co.
(
JPM
),
The Goldman Sachs Group, Inc.
(
GS
) and
Citigroup, Inc.
(
C
) are on review for a two-notch downgrade, whereas
Bank of America Corporation
(
BAC
) is on review for one notch downgrade.
However, if the Fed restricts Morgan Stanley of moving the
derivatives to its bank subsidiary, it can very well transfer it to
a separate wing, known as Morgan Stanley Derivative Products. This
division also possesses a higher credit rating from Moody's.
Conclusion
Morgan Stanley's idea of diverting derivatives to its
subsidiaries should work in its favor in case there is a downgrade
in the rating. Firstly, it will be able to retain its business
which, in given circumstances, could have been taken up by its
rivals with higher ratings. Moreover, the diversion would
positively impact the financials as the interest expense would come
down because of lower funding costs.
Currently, Morgan Stanley retains its Zacks #3 Rank, which
translates into a short-term Hold rating. Considering the
fundamentals, we also maintain our long-term Neutral recommendation
on the stock.
BANK OF AMER CP (BAC): Free Stock Analysis
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CITIGROUP INC (C): Free Stock Analysis Report
GOLDMAN SACHS (GS): Free Stock Analysis Report
JPMORGAN CHASE (JPM): Free Stock Analysis
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MOODYS CORP (MCO): Free Stock Analysis Report
MORGAN STANLEY (MS): Free Stock Analysis Report
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