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Morgan Stanley: Going from Bad to Worse

July 23, 2012

The earnings report of a big bank, from a credit analysis standpoint, has two parts a) a component that cannot be rigged and b) a component that can be rigged and is usually rigged.   The first component includes brokerage income, investment banking fees (assuming that the fee generating transaction does not have any subsidized high risk loans) and other fee based income (again assuming the fees have not been generated through violation of the law of the land, in which case the prospects of penalties and other contingent costs linger in the horizon).     The second component includes loan loss provisions, valuation of illiquid securities (usually valued using models rigged by management.  Someone referred to these as bid 90 offer 10 securities), provision for legal costs and costs from past shady behaviour ( such as MBS underwritten with fraudulent reps and warranties, LIBOR scandal etc).

 We had in the past expressed skepticism about Morgan Stanley’s earnings prospects ( See  Where Morgan Stanley differs from the other big banks is its “unriggable” earnings is very low.  The “riggable” earnings component is as rigged at Morgan Stanley as at other big banks.  The other big banks have grave balance sheet, and off-balance sheet problems like Morgan Stanley.  But they, at least recently, have not had an income statement problem (ignoring the balance sheet adjustments through the income statement).  Morgan Stanley does, and can therefore turn turtle before the others do.  You do need some real earnings to get going -your whole income statement can’t rely on rigged earnings.


From → Credit Analysis

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