Bloomberg News

Goldman, Morgan Stanley Trading May Be Hurt If U.S. Downgraded

August 01, 2011

Aug. 1 (Bloomberg) -- Goldman Sachs Group Inc. and Morgan Stanley’s fixed-income trading revenue would likely be crimped if the U.S. credit rating is downgraded, according to Brad Hintz, a Sanford C. Bernstein & Co. analyst.

A downgrade will bring a “never before experienced” environment with changing rates, currency-market volatility and widening credit spreads, Hintz wrote in a note to investors today. “This environment will negatively impact trading revenue, repo financing and debt capital markets activity,” he said. Both firms have liquidity and capital “to navigate challenging market conditions successfully.”

President Barack Obama and Congressional leaders are rushing to push through a compromise to raise the U.S. debt limit by at least $2.1 trillion and slash government spending by $2.4 trillion or more. Ratings companies including Standard & Poor’s have warned that the nation may lose its top AAA sovereign grade depending on the contents of the debt deal.

While a downgrade is likely to happen soon, firms have had time to prepare for the event, Hintz said. That means the decline in Wall Street’s fixed-income trading revenue will likely be less than the 36 percent drop that followed the 1998 Russian default, he wrote.

“Wall Street’s fixed-income trading units are positioning themselves in anticipation of a downgrade and are minimizing their inventory positions,” Hintz wrote. “These events tend to be painful but relatively short lived.”

Viewed as ‘Manageable’

Goldman Sachs and Morgan Stanley, which are based in New York, may each have to post $5.2 billion in additional collateral for so-called repurchase agreements, Hintz wrote. Banks and other financial companies use U.S. Treasuries as collateral for loans in repurchase-agreements, or repos, and the prospect of a downgrade has raised questions about whether such loans would become more expensive.

Stephen Cohen, a spokesman for Goldman Sachs, and Mary Claire Delaney at Morgan Stanley declined to comment on the note.

Goldman’s senior executives view a potential downgrade of the U.S.’s credit rating as “manageable,” Citigroup Inc. analysts led by Keith Horowitz wrote in a note to investors last week. The analysts said that they met with Goldman Sachs Chief Financial Officer David A. Viniar, Co-Head of Securities Harvey M. Schwartz, and Co-Head of Investment Banking David M. Solomon.

“Management noted that they have run through various scenarios and implied the risk of a U.S. debt downgrade seems manageable, with the important caveat that there is always the possibility of more severe knock-on effects,” the Citigroup note said. Goldman Sachs “noted that collateral agreements related to Treasuries are not dependent on Treasury ratings.”

Morgan Stanley is “not rushing” to raise collateral requirements ahead of a potential downgrade, David Hilder, an analyst at Susquehanna Financial Group LLP, wrote in a note to clients last week, citing a meeting with Ken deRegt, who helps lead Morgan Stanley’s fixed-income trading group.

Only a small number of investors are required to own AAA- rated securities, limiting the impact of a downgrade, deRegt said, according to Hilder’s note.

--With assistance from Christine Harper in New York. Editors: David Scheer, William Ahearn.

To contact the reporter on this story: Michael J. Moore in New York at

To contact the editor responsible for this story: David Scheer at

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