Moody's Investors Service warned it is likely to cut its credit ratings on Morgan Stanley, saying the U.S. investment bank has made expensive trading mishaps and it's unclear if it can improve its risk management.
"Morgan Stanley is making changes to the risk management organization, but Moody's thinks it is premature to conclude that these changes will be effective considering the complexity of the task," the rating agency said in a statement.
"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 a Aa3-rated financial institution," Moody's said.
The most likely result of the rating review will be a cut from "Aa3," the fourth highest investment grade, to the one notch lower "A1" Moody's said.
Morgan Stanley has profitable franchises in investment banking, equities, commodities and prime brokerage, but it also has risky concentrations in commercial real estate and leveraged loans, Moody's said.
"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 said.
Morgan Stanley said on Wednesday its fiscal second-quarter earnings dropped 57 percent on weak trading, investment losses and a slowdown in investment banking, even after it realized $1.43 billion in one-time gains.
The recent collapse of Bear Stearns also highlights liquidity challenges faced by investment banks, Moody's added.
Morgan Stanley's 5.25 percent bond due 2012 widened 24 basis points to 2.62 percentage points over U.S. Treasuries, according to MarketAxess.