U.S. securities firms have ratings cut by S&P

Tuesday, June 3, 2008 at 1:31am
Morgan Stanley, Merrill Lynch & Co. and Lehman Brothers Holdings Inc. plummeted in New York trading Monday. Bloomberg News

Morgan Stanley, Merrill Lynch & Co. and Lehman Brothers Holdings Inc. plummeted in New York trading Monday after Standard & Poor’s lowered credit ratings for the investment banks, saying they may have to book more write-downs on devalued assets.

Morgan Stanley, the second-biggest U.S. securities firm by market value, was cut to A+ from AA-, S&P reported yesterday.

Merrill Lynch, the third-biggest, was cut to A from A+, as was Lehman Brothers, the fourth-biggest. Goldman Sachs Group Inc., the largest of the group, was affirmed at AA-.

“The outlooks on the large financial institutions sector in the U.S. are now predominantly negative,” the S&P statement read.

Morgan Stanley spokeswoman Mary Claire Delaney declined to comment, as did Merrill spokeswoman Jessica Oppenheim and Lehman spokesman Mark Lane.

The “actions reflect prospects of continued weakness in the investment banking business and the potential for more write-offs, though not of the magnitude of those of the past few quarters,” Tanya Azarchs, an S&P analyst, said on Monday.

The ratings downgrades may make it harder for the banks to sell derivatives such as credit-default swaps that are tied to bonds or loans, said Brad Hintz, an analyst at Sanford C. Bernstein in New York. Single-A rated firms are less desirable as trading counterparties for fixed-income derivatives that extend longer than five years, he said.

“You’ll see derivatives profitability drop off over a period of time,” Hintz said of the three downgraded investment banks. “We estimate somewhere around 1 percent to 1.5 percent of fixed- income revenues are at risk.”

The firms are also likely to have to post more collateral on the trades they've already made with other parties, raising their costs, Hintz said.

Morgan Stanley, Merrill and Lehman sank in New York Stock Exchange composite trading, with Lehman dropping as much as 8.8 percent. The cost of insuring against a default on each of the companies’ debt jumped.

Lehman was down $2.43, or 6.6 percent, to $34.38 at 2:17 p.m. in NYSE composite trading, after falling as low as $33.58 earlier Monday. Merrill was down $1.33, or 3 percent, to $42.58, while Morgan Stanley lost $1.46, or 3.3 percent, to $42.77. Goldman was down $3.70, or 2 percent, at $172.71.

The S&P report suggested the banks might have to sell more stock to help offset their asset write-downs, according to Hintz. The report said financial institutions have raised too much capital in the form of so-called hybrid securities, exceeding S&P’s limits on such instruments.

“The risk of further equity dilution probably has gone up,” Hintz said.

The biggest banks and securities firms have booked about $387 billion of write-downs and credit losses since the beginning of last year, as the collapse of the subprime mortgage market prompted a contraction in credit markets worldwide. So far, the firms have raised about $270 billion of capital.

S&P said yesterday that it revised its outlook on Bank of America Corp. and JPMorgan Chase & Co. to negative. Citigroup Inc. was taken off review for a downgrade and given a negative outlook, while Wachovia Corp. was placed on review for a downgrade.

Wachovia shares yesterday fell to the lowest level since July 1995 after the bank ousted Chief Executive Officer Kennedy Thompson, signaling the company may report a second-quarter loss.

— Bloomberg News

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