Morgan Stanley (MS:US), owner of the world’s largest brokerage, was upgraded to buy by UBS AG (UBSN) after the firm’s shares dropped to a level Chief Executive Officer James Gorman deemed “inexplicable.”
Drags on trading revenue from Europe’s debt crisis are already reflected in the price of Morgan Stanley’s stock, which has fallen 23 percent this month, UBS analysts led by Brennan Hawken said in a note to investors today. That valuation, less than half the tangible book value, reflects “a very negative outcome,” and the shares should rise about 30 percent, Hawken wrote.
The bank may face lower trading revenue as client activity dwindles and credit spreads widen, with JPMorgan Chase & Co. (JPM:US) analyst Kian Abouhossein estimating today that Morgan Stanley’s fixed-income revenue may drop 31 percent. The lender’s stock has also fallen because of concern that Moody’s may cut its credit rating three levels and that the firm may face increased regulation after JPMorgan’s $2 billion trading loss, Susquehanna Financial Group’s Doug Sipkin wrote today.
“I find the stock trading around half-book to be a little inexplicable, but these markets are fragile,” Gorman, 53, said this week at the company’s annual meeting. “I believe in the long-term strategy for our business, I’m very comfortable with it, and I think we’re positioned well. Short-term, I’m not going to lose any sleep over it.”
Tangible book value is the bank’s estimate of how much money would remain if all its assets were liquidated and liabilities paid off. The bank should trade between 60 percent and 70 percent of adjusted tangible book value, Hawken said.
Morgan Stanley fell 0.8 percent to close at $13.35 in New York. The bank’s shares have dropped 26 percent since rising to $18.07 on April 19, when the firm reported first-quarter results that beat estimates. The stock is down 12 percent this year, after falling 44 percent last year and 8.1 percent in 2010.
Morgan Stanley’s credit ratings may be reduced by as many as three levels, the largest potential downgrade among U.S. lenders, Moody’s has said. The ratings firm will take action by the end of June, according to a statement last month.
“We believe investors have over penalized” Morgan Stanley, Susquehanna’s Sipkin said, recommending investors buy the bank’s shares and sell Jefferies Group Inc. (JEF:US) stock. “With respect to Moody’s, we believe a three-notch rating downgrade is more than discounted in MS stock at this point.”
Credit Spreads Widen
A downgrade could force Morgan Stanley to post more collateral on derivatives trades and pay more to borrow. Gorman said last month the investment bank has taken steps to ensure any fallout from a downgrade would be manageable, and Chief Financial Officer Ruth Porat, 54, said the firm has liquidity of $179 billion.
Morgan Stanley’s credit spreads have widened in the last month, with credit-default swaps on the bank’s five-year senior debt climbing to 454 basis points yesterday, the highest level since November. A basis point is a hundredth of a percentage point.
“The financial sector has been under stress, and all of the companies’ spreads aren’t where they’d ideally long-term like them to be,” Gorman said this week.
International Strategy & Investment Group Inc.’s Ed Najarian cut his second-quarter earnings estimate by 17 cents this week as he sees a 40 percent drop in fixed-income trading revenue from the first quarter.
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