Morgan Stanley bond business hurt by Moody's rating cut

(Reuters) - Morgan Stanley's bond-trading business suffered during the second quarter as clients fretted that its credit ratings could be cut to just two steps above junk, but that cloud has since lifted, the investment bank's CFO said on Thursday.

The downgrade came in late June and was not as bad as many investors had feared - Moody's Investors Service cut the bank's main rating to "Baa1," three steps above junk.

The bank has had to post $3.7 billion of collateral since the downgrade, but business has improved and the pace of collateral calls has slowed since late June, Chief Financial Officer Ruth Porat said in an interview.

"We're certainly seeing that the weight of that Moody's decision has lifted," she said.

But during the second quarter, the threat of the downgrade hurt the bank, she added.

"We spent a lot of time with clients and counterparties addressing questions they might have - and that's time that otherwise would have been spent focusing on getting new business," said Porat.

"As the quarter wore on, in particular as Moody's extended the timeline for making its decision, it really just put more weight on the whole situation. Clients seemed to take this wait-and-see approach."

Morgan Stanley on Thursday reported second-quarter earnings that generally beat what many analysts had expected, but the downgrade details and fixed-income trading performance weighed on its stock. The shares were down 2.8 percent in early trading.

The investment bank posted a profit of $564 million, or 29 cents per share, compared with a loss of $558 million, or 38 cents per share, a year earlier. Morgan Stanley also lost money in the first quarter.

The 2011 second-quarter results included a charge linked to the bank's conversion of preferred stock owned by Japan's Mitsubishi UFJ Financial Group into common stock.

Overall revenue fell 24 percent to $6.95 billion. The total included a $350 million gain from changes in the value of Morgan Stanley's debt relative to Treasuries, known as a debt valuation adjustment, or DVA.

Excluding such gains, fixed income sales and trading revenue dropped 60 percent to $770 million.

Revenue from other businesses also fell amid weak trading and dealmaking, but not as sharply as fixed-income trading.

Equity trading excluding DVA fell a less harsh 36 percent, to $1.1 billion. Revenue from merger advisory dropped 51 percent to $263 million, and revenue from underwriting fell 34 percent to $621 million. Wealth management and asset management revenue also fell.

The bond-trading decline was a particularly harsh setback for Morgan Stanley. The bank has been focused on building out its fixed-income trading business, which suffered big losses during the financial crisis and underperformed in 2009 when credit markets opened up again.

(Reporting By Lauren Tara LaCapra; Editing by John Wallace)

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