Morgan Stanley (MS:US) is likely to face a two-level downgrade of its credit rating from Moody’s Investors Service in the next two months, said Donald Jones, a Sterne Agee & Leach Inc. credit analyst.
The chance of a two-grade cut is 75 percent, which may cause the firm’s credit spreads to tighten slightly, Jones wrote in a note to clients today. A one-level downgrade is more likely than three levels, the maximum reduction Moody’s said in February that it would make, he wrote.
Morgan Stanley faces the largest potential credit downgrade among U.S. lenders by Moody’s, which will take ratings actions on the biggest global investment banks by the end of June. A three-level cut would bring the rating to Baa2, two levels above junk, from A2. That could force the firm to post more collateral on derivatives trades and pay more to borrow.
“We expect that Moody’s will downgrade most if not all of the firms put on watch in February, however we think the downgrades will rest at the ‘better end’ of the spectrum,” Jones said in the note. “Part of this expectation is in light of generally positive first-quarter 2012 results.”
Morgan Stanley Chief Executive Officer James Gorman and Chief Financial Officer Ruth Porat said last month that they’ve taken steps to ensure any fallout from a downgrade would be manageable.
A three-level downgrade, a 5 percent to 15 percent possibility, would lead to spreads widening as much as 1 percentage point, Jones wrote. A one-level cut, a 10 percent to 20 percent likelihood, would cause a rally to the spreads Morgan Stanley had in February, he wrote.
There is “zero likelihood” of Moody’s not cutting the bank’s credit rating at all, he wrote.
Jones cited “the posturing and defensive language in conversation with the agency” as a reason for his expectation that a two-level cut is most likely.
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