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UPDATE:Morgan Stanley Earnings Reignite Financial Firm Fears

Last Update: 6/18/2008 12:40:41 PM

(Updates with additional investor comment and fresh CDS and CDX levels)

By Kate Haywood

Of DOW JONES NEWSWIRES

NEW YORK (Dow Jones)–The cost of debt protection for Morgan Stanley (MS) moved
wider Wednesday after the investment bank unveiled a 60% slump in second-quarter
profit, reaffirming fears about financial firms.

Five-year senior credit default swaps, or CDS, on Morgan Stanley initially traded
at 164 basis points, following the results and has since moved wider to 168 basis
points, according to broker Phoenix Partners Group in New York. The CDS closed
Tuesday’s session at 160 basis points, Phoenix Partners said, adding that the
five-year contract had traded at 167 basis points prior to the earnings release.
Another trader however pegged the CDS at 158/163 basis points first thing
Wednesday.

This means the annual cost of protecting a notional $10 million of Morgan Stanley
bonds against default for five years is now $168,000 versus $160,000 late
Tuesday.

Net revenue at the bank’s fixed-income trading powerhouse fell 85% amid a $436
million loss from trading mortgage-related assets, and weak results in the
booming commodities area. Morgan Stanley also lost money on investments on real
estate and in private equity, traded poorly for its own account in equities, and
had to take a $120 million loss after a credit trader violated company policy and
improperly valued his positions.

Just a day after Goldman Sachs (GS) gave investors a glimmer of hope that the
credit crunch may be turning a corner, Morgan Stanley’s numbers raise question
marks over whether the market and indeed, the firm itself, is emerging from the
crisis, or whether there is still more bad news on the horizon.

Investors’ fears were exacerbated last week when Lehman Brothers (LEH) warned it
would report a $2.8 billion loss for the second quarter, its first quarter in the
red since the brokerage went public in 1994. It confirmed the loss Monday.

Goldman Sachs however managed to allay some of those concerns Tuesday after it
posted better-than-expected second-quarter results, which smashed analysts’
expectations.

“Having a positive number in front of your earnings is a good thing,” said Carl
Kaufman, portfolio manager at Osterweis Strategic Income Fund in San Francisco,
Ca.

But he said that the earnings reports don’t provide the clarity the credit market
needs in terms of how banks and brokers’ have marked down valuations on their
assets.

Market participants are, rightly so, continuing to remain cautious. Analysts at
BNP Paribas said in a note to clients late Tuesday that despite the relatively
solid results at Goldman, earnings and earnings quality continue to deteriorate
for financials, and particularly for brokers.

“It’s a case of two steps forward and one step back,” said Jim Cusser, portfolio
manager at Waddell & Reed in Overland Park, Kan.

The slightly weaker tone in the high-grade credit market is reflected in widening
in the benchmark high-grade derivatives index. The Markit CDX IG10 was quoted at
113 basis points following Morgan Stanley’s results, according to Phoenix
Partners. It has since come in a touch to 112 basis points, data from Moody’s
Investors Service’s CreditQuotes showed at lunchtime.

The index closed Tuesday at 109 basis points, according to Markit. That means the
annual cost of protecting a notional $10 million on bonds from a basket of 125
North American high-grade companies for five years is now $112,000, compared with
$113,000 earlier Wednesday and $109,000 Tuesday.

Also contributing to the more negative sentiment Wednesday, economic bellwether
FedEx Corp (FDX) said it swung to a fourth-quarter loss, hurt by a charge related
to its 2004 purchase of Kinko’s. It also cut its fiscal 2009 profit outlook,
citing the spike in fuel costs and restrained demand.

Although wider, Wednesday’s moves in the CDX and individual financial names are
tame when compared with the volatility seen earlier this year when the market was
prone to massive swings in risk premiums or spreads on a daily basis. But since
the dramatic rescue of Bear Stearns Cos. (BSC), the market has become much
calmer. Although investors are constantly reminded that it isn’t going to be easy
to shake off this crisis that began a year ago, there is nowhere near the panic
seen in March.

“It’s amazing how we become immune to bad news after a while … nothing really
surprises me in this market any more now,” said one market participant, who
preferred not to be named.

“The 17th time you hear bad news it’s ‘yeah whatever …’,” the market
participant added.

-By Kate Haywood, Dow Jones Newswires; 201-938-2348; kate.haywood@dowjones.com

(Rob Curran and Donna Kardos contributed to this report.)

(END) Dow Jones Newswires

June 18, 2008 12:40 ET (16:40 GMT)

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