The leveraged loan commitments of the major U.S. investment banks do not have negative rating implications at this time, says Moody’s Investors Service in a new report.

The five firms (Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch, and Morgan Stanley) have sufficient liquidity to fund their commitments, while continuing to maintain strong liquidity profiles, and the earnings impact of marking down the commitments to reflect today’s wider credit spreads should be manageable, Moody’s says.

“Firms maintain a strong cash capital and overall liquidity position to deal with the funding risks presented by the challenging conditions in leveraged loan distribution,” says Moody’s senior vice president Peter Nerby. “Furthermore, we believe that they have sufficient earnings strength and diversification to be able to absorb the necessary mark-downs on the loan pipeline while still generating positive, albeit depressed, earnings and a respectable level of profitability.”

The rating agency notes that the sharp and sudden widening of credit spreads on speculative-grade debt has resulted in the majority of investment banks’ leveraged loan commitments being “under water”. This situation has potential liquidity and revenue implications for the firms, given the difficulties in distributing the loans in the secondary market and the decline in the market values of leveraged loans resulting from higher spreads, it adds.

With respect to liquidity, Moody’s expects that firms will maintain surplus cash capital and sufficient liquidity even if they have to fund their leveraged loan commitments and retain them on their balance sheets. “Sound liquidity is a critical factor underpinning our ratings,” says Nerby. “It is particularly vital during today’s challenging market environment.” Moody’s will continue to actively monitor the liquidity profiles and funding plans of its rated securities firms.

To estimate the potential earnings impact on firms of marking down their lending commitments, Moody’s performed an earnings stress test. The stress test attempts to quantify the potential revenue and earnings impact of marking down the commitments to reflect today’s higher credit spreads on high-yield debt.

The stress test shows a level of performance during a challenging market environment that, while weakened, does not hold negative rating implications. Moody’s considers the revenue diversification of the major investment banks, by business line, geography and asset class, as an important counter-balance to the difficult environment in the sub-prime and leveraged loan markets.

While concluding on the absence of negative rating pressure at present, Moody’s also noted that the dislocation in the leveraged loan market was emblematic of the growing capital intensity in the industry. “This current situation highlights our long-standing concerns about the growth in illiquid risk assets, including lending commitments, at the large U.S. investment banks,” says Nerby.