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Moody's Eyeing Morgan Stanley For Possible Downgrade
The short-term Prime-1 ratings of Morgan Stanley and its guaranteed subsidiaries were affirmed.
June 27, 2008
Moody's Friday put Morgan Stanley's long-term ratings on review for possible downgrade, citing concerns about the credit markets and their impact on the banking giant.
The short-term Prime-1 ratings of Morgan Stanley and its guaranteed subsidiaries were affirmed.
Moody's said the more likely outcome of the review process would be a downgrade of Morgan Stanley's long-term rating to A1. By affirming the Prime-1 rating, Moody's said the outcome of this review would not result in a long-term rating below A2.
Since the onset of the credit crisis one year ago, Morgan Stanley's financial performance and risk management has been inconsistent, and below the levels expected of an Aa3-rated financial institution. Excluding recent gains from asset sales, Morgan Stanley has reported a pretax loss of nearly $1.4 billion over the past year, Moody's said.
"Markets have clearly been challenging, but the firm has also incurred some expensive trading mishaps during the past year," Moody's said. While Morgan Stanley is making changes to the risk management organization, Moody's thinks it is premature to conclude that these changes will be effective considering the complexity of the task.
During its review, Moody's will focus on Morgan Stanley's ability to control risk and generate higher levels of profitability over the next one to two years, during which the operating environment may remain challenging for securities firms. Moody's noted that the firm has profitable franchises in investment banking, equities, commodities and prime brokerage and has improved performance within retail brokerage. On the other hand, the firm has some risky concentrations in commercial real estate and single-name leveraged loans. The critical issue will be for Morgan Stanley to manage these and other concentrations, and their attendant basis risks such that any losses are well contained within the revenue capacity of the relevant business area.
Moody's noted that the recent collapse of Bear Stearns highlights the vulnerability of the secured funding model of Morgan Stanley and other investment banks to overall market liquidity. When market liquidity dries up, collateral becomes harder to value, margin disputes arise, and pressure on an investment bank's funding increases. The supportive actions of the Federal Reserve, including the Term Securities Lending Facility and the Primary Dealer Credit Facility, have played a critical role to stabilize funding markets in the wake of the Bear Stearns collapse. These actions have provided at least an interim solution to industry-wide structural liquidity challenges.
However neither facility is permanent in nature. In the absence of a more permanent solution Moody's believes that the newly revealed vulnerability of the secured funding model may warrant negative action on investment banks that rely on that model.
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