Fitch Weighing Costs and Benefits of Goldman Sachs & Morgan Stanley as FHCs

CHICAGO--(BUSINESS WIRE)--Fitch Ratings is evaluating the potential short- and long-term rating implications of both Goldman Sachs and Morgan Stanley against recent market events and their recent change in status as Financial Holding Companies.

Fitch currently rates both entities as follows:

--Long-term IDR 'AA-';

--Senior debt 'AA-';

--Short-term IDR 'F1+'

--Individual 'B'

--Support '5'.

--Support Floor 'NF'.

The Rating Outlook on Morgan Stanley's long-term IDR is Negative, while the Rating Outlook is Stable for Goldman Sachs' long-term IDR.

Goldman Sachs and Morgan Stanley are now under direct supervision of the Federal Reserve. Conditions of approval included strong liquidity and being well-capitalized under current regulatory requirements. These conditions are consistent with Fitch's current ratings.

Ratings impact will be measured against several positive expectations, including:

--Reduced leverage;

--Permanent and direct access to the Federal Reserve Discount window;

--Greater efficiencies in counterparty netting with a potential for fewer legal entities and less trapped regulatory capital; and

--Potential of the Paulson plan to provide an opportunity to shed higher risk assets.

Both firms will benefit from direct access to the Fed Discount window and while the primary dealer credit facility (PDCF) is similar, they benefit from the permanency and broader collateral eligibility at the Fed Discount Window, including the ability to pledge whole loans. The firms already possess bank charters that may be converted from industrial loan companies to national or state banks. A national bank charter would relieve the firms from branching restrictions. In addition, branching internationally may reduce the multiple legal entities in various jurisdictions, allowing more counterparty netting which could then lower collateral and contingency funding requirements and concerns.

Fitch will evaluate other benefits of financial holding company status in addition to any changes in the overall risk appetites of these institutions and subsequent profitability. The transition to and ongoing development of the universal bank model has not been an automatic success for other firms in the industry. Current global economic conditions add to the challenges.

Capital has been adequate under Fitch's leverage expectations and strong under regulatory capital rules of the Securities Exchange Commission. Both institutions have obtained approval to use internal models to evaluate both market and credit risks and reported high levels of Tier 1 capital for the past two quarters. Fitch also notes however; that the reporting of strong capital ratios has not been sufficiently convincing for other investment banks to garner additional capital. Equity and CDS prices have had substantial influence on financial flexibility across several financial institutions not just broker dealers in this extreme environment. In certain cases, this has increased the risk of liquidity calls placing significant financial pressures on several firms. Goldman Sachs and Morgan Stanley may experience some liquidity and capital pressures despite the strength of core performance as they respond to counterparties' discomfort with the broker dealer business model.

Fitch expects trading operations to continue to be reliant on secured and unsecured funding sources and dependent upon prudent management of collateral and appropriate evaluations of client risk. The tenor and diversification of both secured and unsecured sources of funding remain very relevant. Fitch will evaluate the firms' plans for usage of retail deposits, legal entity constructs and alternative sources of funds. An important element of this review will be regulatory tolerance for usage of retail deposits in trading operations and what, if any, compensating factors will be required to mitigate inherent risks.

Fitch will also evaluate any changes to risk appetite, business model and legal entities. Potential efficiencies through consolidation and greater use of netting may improve liquidity and or reduce capital requirements. Fitch will evaluate the extent to which business strategies are modified and capital needs change. Profitability may be negatively impacted by lower leverage and reduced risk appetite. Innovation may also be hampered by reduced incentives either through equity ownership or other compensation. Ratings may be negatively affected or wider notching employed for select issues based on capital composition. These firms will continue to be evaluated against a broad peer group of complex financial institutions.

Fitch's rating definitions and the terms of use of such ratings are available on the agency's public site, www.fitchratings.com. Published ratings, criteria and methodologies are available from this site, at all times. Fitch's code of conduct, confidentiality, conflicts of interest, affiliate firewall, compliance and other relevant policies and procedures are also available from the 'Code of Conduct' section of this site.