Morgan Stanley Joins Citigroup, Bank of America in the Doghouse

Morgan Stanley "could immediately mitigate the impact of the ratings downgrade by shifting its OTC derivatives book into its higher rating bank subsidiary," according to Hintz, though he adds that derivatives provisions in the 2010 Dodd Frank legislation "might limit the effectiveness of this action over time."

BlackRock Inc. CEO Larry Fink told The New York Times last month that "if Moody's does indeed downgrade these institutions, we may have a need to move some business around to higher-rated institutions."

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In addition to the downgrade threat, Morgan Stanley's return on equity has been poor. There are various ways of measuring this, though one that is particularly troubling for Morgan Stanley looks at net income excluding one-time charges. On this basis over the past 12 months, Morgan Stanley has returned negative 0.53%, the worst of the big six, according to Bloomberg data,. Bank of America, the next worst performer by this metric, has returned 4.7%.

These factors may explain why, despite its low valuation, Morgan Stanley is not an analyst favorite. On a Bloomberg proprietary scale of one to five with five being the best, Wall Street analysts rate Morgan Stanley 3.48, ahead of only Bank of America. JPMorgan, the analyst favorite, has an average rating of 4.65.

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Bernstein's Hintz, nonetheless, has an "outperform" recommendation on Morgan Stanley. Hintz argues the bank is in the midst of transforming its business to become a top retail broker and investment bank that is "less reliant on trading with a lower-risk business model." Hintz expects the company to achieve this goal by 2014.

-- Written by Dan Freed in New York.

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