Morgan Stanley's corporate borrowing costs are already way higher than Goldman Sachs and more downgrades are likely in the works.
The Fiscal Times explains How Morgan Stanley sank to junk pricing
The bond markets are treating Morgan Stanley like a junk-rated company, and the investment bank’s higher borrowing costs could already be putting it at a disadvantage even before an expected ratings downgrade this month.
Bond rating agency Moody’s Investors Service has said it may cut Morgan Stanley by at least two notches in June, to just two or three steps above junk status. Many investors see such a cut as all but certain.
Even before any downgrade, the bank is suffering in the bond markets. Prices for Morgan Stanley’s bonds and credit derivatives have been trading at junk levels since last summer, according to Moody’s Analytics. Prices moved further into the non-investment-grade category over the past two weeks amid troubles in Greece and other Euro zone nations.
"The numbers have changed for the worse," said Otis Casey, director of credit research at Markit. "What has driven that, obviously, is Europe. The perception is – correctly or incorrectly – that Morgan Stanley is one of the U.S. banks most exposed to Europe’s problems."
Morgan Stanley’s problems were compounded by its handling of the Facebook IPO – its high price and large size, and selective disclosure of an analyst’s reduction of his forecasts for the social network’s revenue and earnings. Facebook shares ended regular trading at $27.72 on Friday, down 27 percent from their offering price of $38.
"A bank with a near-junk rating is in ‘no man’s land,’" said Edward Marrinan, credit strategist at Royal Bank of Scotland Group in Greenwich, Connecticut. "Banks rarely thrive with non- or borderline investment grade ratings."
In a May 7 securities filing, Morgan Stanley said it might have to post $7.2 billion worth of additional collateral and termination payments in the event of a downgrade to Baa2, the second lowest investment-grade rating, up from a $6.5 billion estimate it provided three months earlier.
But bond markets are not waiting for a downgrade. On Friday, it would have cost Morgan Stanley 1.20 percentage points more to raise five-year debt than its chief rival, Goldman Sachs Group Inc. The bank would even have to pay a little more than much-smaller competitor Jefferies Group.
"The Street is pretty efficient and is really moving ahead of the ratings agencies," said Carret Asset Management’s Graybill. "It’s never good in this business to have a disadvantage against a strong competitor."
The massive losses which resulted from JPMorgan Chase hedging its positions against derivatives has once again cast the spotlight on the Volcker Rule and whether systemically important financial institutions (SIFIs) are too big to fail, industry observers said. Questions have also been raised about the firm’s hedging strategy, and what constitutes hedging in the first place.
Industry officials in Asia suggested that JPMorgan’s $2 billion hedging losses might embolden regulators to strengthen the Volcker Rule, on the premise that it would be of benefit to SIFIs. The rule, named after former Federal Reserve chairman Paul Volcker, forms part of the Dodd-Frank Wall Street Reform and Consumer Protection Act and has proposed the separation of proprietary trading from commercial banking activity. Most notably, it has argued against investing in derivatives or using derivatives as a hedge on investments. The rule has, however, faced strong opposition from many of the large global financial institutions.
Top five SIFIs’ OTC derivatives exposures
A look at the 2011 fourth quarter bank trading and derivatives activities report released by the U.S. Office of the Comptroller of the Currency (OCC) showed that the top five SIFIs — Bank of America, Citibank, Goldman Sachs, HSBC and JPMorgan — collectively accounted for more than 50 percent of the $700 trillion OTC derivatives trades worldwide in total notional value. JPMorgan alone accounted for more than $70 trillion of the $700 trillion, the report said. “That [$70 trillion] represents one-tenth of the global OTC derivatives exposures. This is what I call concentration of risk and what is defined as an institution that is too big to fail,” an industry official told Thomson Reuters on condition of anonymity.
The official said he found it alarming that, when the top five banks’ assets and total exposures to derivatives activities were added up, they showed a leverage of one to 45 times. The OCC report showed that JPMorgan Chase North America has total assets of $1.8 trillion to cover $70 trillion worth of OTC derivatives exposure. JPMorgan Chase & Co has total assets of $2.26 trillion, the report also stated.
“Five to 10 years ago, a leverage of one to 10 times was considered scary but now we are talking about a leverage of one to 45 times. The questions to ask JPMorgan are: ‘Were you using these derivatives for speculation or for hedging purposes?’ and ‘Can you qualify your definition of hedging?’” he said.