Standard & Poor’s Ratings Services has upgraded its outlook for two big Wall Street firms, Morgan Stanley and Lehman Brothers, while affirming its stance on rivals, Merrill Lynch, Goldman Sachs and Bear Stearns.

S&P revised its outlook on Morgan Stanley to positive from stable, indicating that over the medium term, if current trends continue, the firm’s issuer credit ratings could be raised. “Morgan Stanley’s earnings performance, as reported, over the past several years has exhibited low volatility relative to that of its peers,” it notes, and its non-operating charges have been minimal and capital position is strong.

The positive outlook is tempered by legal risks related to IPO practices, research independence, and mutual funds, and risks from proprietary trading, S&P says.

Lehman Brothers Holdings Inc. also saw its outlook revised to positive from stable. “Management has so far successfully executed its strategy to reduce reliance on fixed-income capital markets activities by increasing the contributions from investment banking and asset management,” the rating agency says. However, it notes that Lehman’s ratings strengths are somewhat offset by the firm’s trading risk appetite and exposure to illiquid and credit intensive assets.

Goldman Sachs Group Inc. saw its ratings affirmed, with a stable outlook. “The ratings are based on the firm’s strong market positions in investment banking, securities trading, and asset management; strong culture; and management team. These strengths are somewhat offset by the firm’s high appetite for market risk in its trading positions and in illiquid investments,” it says. “However, Standard & Poor’s believes that Goldman manages its market risks well. The firm’s capital adequacy is strong and overall liquidity is excellent.”

Goldman’s earnings have grown substantially over the past two years, due to a sharp increase in trading revenue. Substantial earnings growth in fixed income and currencies trading, asset management, investment banking, and securities services have more than offset continuing weakness in equity trading, it notes.

Merrill Lynch Co. Inc.’s ratings were affirmed based on its business line diversification, strong market positions in investment banking, securities trading, and retail brokerage. “Over the past three years, the management team has been very successful in cutting costs and repositioning businesses. This has increased Merrill Lynch’s profitability so that it is in line with that of its peer group,” S&P says. “Merrill Lynch also has a strong capital position and excellent liquidity. On the downside, the firm faces the risk of high expenditures to resolve various lawsuits due to investment banking and brokerage activities.”

Bear Stearns’ ratings are based on its strong franchises in equity and fixed income securities market making and prime brokerage services as well as the long-term stability of earnings and low market risk appetite. “The stable outlook is based on the expectation that the firm will maintain the strength of its business franchises. Bear Stearns‚ business mix is not as diversified as larger competitors, and this may limit higher ratings,” it notes. “Standard & Poor’s feels that long-term earnings stability is due to a low risk appetite, which is a positive factor for the ratings.”

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