Fitch Ratings has affirmed its ratings of Morgan Stanley, following today’s disappointing earnings release from the Wall Street investment firm.

The rating outlook remains negative.

Earlier today, Morgan Stanley reported income from continuing operations for the fiscal year ended November 30 of US$2. 6 billion, compared with US$6.4 billion a year ago. Net income for the year was US$3.2 billion, compared with US$7.5 billion a year ago.

Net revenues of US$28. billion were the second highest in firm history, although they decreased 6% from the record revenues of US$29.8 billion in 2006. Non-interest expenses of US$24.6 billion, up 19% from 2006. The return on average common equity from continuing operations was just 7.8%, compared with 23.8% the prior year.

The loss from continuing operations for the fourth quarter was US$3.6 billion, compared with US$2.0 billion in the fourth quarter of 2006. Net revenues were negative US$450 million, compared with US$7.9 billion in last year’s fourth quarter. Non-interest expenses of US$5.4 billion increased 3% from last year.

The firm’s additional US$5.7 billion writedown of US subprime, and other mortgage related exposures in November, and the US$3.7 billion writedown as of October 31, result in a total fourth quarter writedown of approximately US$9.4 billion.

Fitch reviewed Morgan Stanley’s ratings due to the sizeable loss. “The trading position and subsequent loss, while outside Fitch’s expectations, is consistent with the extreme stress scenario that prevails upon mortgages and structured credit products,” it says. Fitch also believes that some of the recognized losses may eventually be recovered as current marks to market result from very dire assumptions about default probabilities and severity for U.S. based mortgages. Further declines are possible but considered unlikely.

The ratings affirmation is supported by Morgan Stanley’s prudent management of liquidity and additional capital raising to support its market risk appetite. Fitch expects securities firms to experience some level of earnings volatility and previously noted the elevated market risk appetite under CEO John Mack. Higher investments remain targeted to enhance the performance of Morgan Stanley.

The diversification of Morgan Stanley’s business across its investment banking and trading platform are critical to the long term ratings outlook, the rating agency says. Fitch believes Morgan Stanley possesses significant competitive advantages in investment banking, prime brokerage, commodities trading and advisory businesses.

As the credit environment has deteriorated, Morgan Stanley has demonstrated swift and proactive behavior in liquidity management, it notes. “Leveraged financing commitments have declined materially and while credit risk remains elevated, hedging activities are expected to mitigate direct exposure to a credit downturn. Management changes were also made which demonstrate accountability, an important element in risk management and culture,” it adds. “Risk management is also expected to enhance stress scenarios and credit risk assessments with goals to reduce or mitigate concentrated positions.”

The Negative Outlook is indicative of a potential ratings downgrade over an intermediate time frame. In 2008, Fitch expects the investment banks to modify risk appetites, increase capital allocated to trading and credit, and revisit expansionary strategies, particularly those related to credit products. Fitch also believe credit markets will remain challenging in the near-term and expects earnings for the investment banks to be dampened with greater volatility in Q4 and 2008. Thus, Fitch looks to expense reductions to prevent erosion in pretax profit margins and ROEs below prior stressed markets.