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SAN FRANCISCO -- Predictably, excitement has given way to consternation over what prompted the

Federal Reserve's

intermeeting rate cut last Wednesday. Stocks proved unable to sustain early momentum today and the

Dow Jones Industrial Average

fell 0.7%, the

S&P 500

lost 1.2% and the

Nasdaq Composite Index

shed 2.1%. More troubling to some, all three indices closed below the respective intraday highs hit April 18 in the wake of the Fed's latest rate-cut gambit.

For those unwilling to take the Fed's

statement at face value, much of the "why'd they do it?" speculation has focused on developments in emerging markets, specifically Argentina. Additionally, somewhat rote concerns were voiced last week about a major Wall Street firm possibly facing financial distress.

Morgan Stanley Dean Witter


was one firm mentioned as facing potential problems, specifically due to its exposure to telecommunication firms' debt.

Such talk quickly subsided and Morgan Stanley executives deny any problems of the sort. The intent here is not to revive the scuttlebutt but to review the situation. Because Morgan Stanley was one subject of rumors, it's worth examining the company's vulnerability to the telecom sector's financial woes. What we find is a company that is deeply entrenched but apparently not dangerously so -- certainly not enough to compel the Fed to act.

The impetus for the gossip last week was the fact Morgan Stanley issued a $6 billion global bond offering last Wednesday, the largest ever for a U.S. financial services firm. The deal was "upsized significantly," as the firm's press release declared, from an originally planned $2.5 billion.

In an interview late last week, Alex Frank, Morgan Stanley's treasurer, claimed "the reception for and market for this bond

offering, is an indication of the fact we don't have material risk issues associated with" telecom debt.

That's debatable, but investors did scoop up the $3.5 billion of Morgan's five-year bonds yielding 6.12% and $2.5 billion of 10 years that yield 6.82%.

Still, skeptics wondered if Morgan Stanley Dean Witter was financially sound, why did it need to raise $6 billion? The dramatic increase in deal size was precipitated by the Fed's rate cut, which got the

black helicopter crowd in a frenzy. Perhaps the Fed knew of some impending implosion at Morgan Stanley, they mused, and so timed the rate cut in order to goose the capital markets to "bail out" the firm (a bit of a stretch for even this admitted conspiracy hound).

Frank made no bones (or qualms) about the fact Morgan Stanley benefited from the Fed's surprise ease, suggesting the firm was being an "opportunistic issuer" by increasing the deal from $2.5 billion to $6 billion.

"When the receptivity is there, we like to take advantage" and thus "can avoid issuing when we don't think market conditions are as good," he said.

Hounds of Telecom-Ville

Concerns about Wall Street's exposure to telecom firms facing (or already in) bankruptcy are not new, and worries about Morgan are somewhat logical. The company took a $90 million charge in the second half of 2000 due to nonperforming high-yield bonds on its books. Furthermore, Morgan has been a very active underwriter of telecom deals in recent years.

In 1997, 1998 and 1999, Morgan Stanley was among the top three underwriters of telecom debt and equity, with a combined 100 deals totaling nearly $27.8 billion, according to

Thomson Financial Securities Data

. Morgan was No. 1 in 2000, underwriting 50 telecom debt and equity offerings that raised more than $24 billion. Through April 19, the firm was second-ranked in 2001, having underwritten 12 deals that raised nearly $6 billion, according to Thompson.

In a 10-Q filing with the

Securities and Exchange Commission

on April 16, Morgan Stanley reported its exposure to high-yield instruments had fallen to $2 billion on Feb. 28 vs. $2.2 billion on Nov. 30, 2000. The market value of high-yield instruments sold, but not yet purchased, was unchanged at $500 million. Morgan officials declined to specify how much of the debt is telecom-specific.

As of Feb. 28, the company had provided loans and/or other financing commitments totaling $4.8 billion to clients with noninvestment grade ratings vs. $2.2 billion on Nov. 30.


figures are pretty reasonable

and manageable" relative to the company's balance sheet and equity capital, Frank said. Indeed, the company had assets over $450 billion on Feb. 28, including cash and equivalents of $21.7 billion. Morgan Stanley also has an outstanding commitment from a group of banks to provide up to $5.5 billion in capital.

Overall, "I don't think their

telecom exposure is outsized," said Tanya Azarchs, managing director at

Standard & Poor's

, which maintains a AA- rating on Morgan's long-term debt.(

Moody's Investors Service

also rates the debt as investment grade, at Aa3.)

Azarchs noted Morgan Stanley was able to shed most of its exposure to



debt with the completion of the Agere


spinout on March 28. (Morgan swapped Lucent commercial paper for an equity stake in Agere, which it subsequently sold.)

Past, Present and Future

Still, concern about the telecom debt issue partially explains why Morgan Stanley shares have struggled this year despite aggressive Fed rate cuts. Additionally, there are questions of how the firm's bond business will be run following the departure of several key executives in the group. (Just today Morgan announced it was closing its Canadian bond operations amid ongoing speculation that wider layoffs are forthcoming.)

After falling 3.5% to $61.60 today, Morgan Stanley has now rallied 36% from its April 4 closing low of $45.26. But the stock remains down 22.3% year to date vs. a 13.7% decline for the Amex Broker/Dealer Index (no doubt frustrating followers of

Jim Cramer's

Action Alerts).


late February, Stanley Nabi, managing director at

Credit Suisse Asset Management

, said he would hold off buying Morgan shares, believing there was "some bad news coming." At the time, Morgan was trading around $70.

Today, Nabi said he considers Morgan Stanley a "core holding"

and "management has demonstrated they are in control of their business." But he would not buy more shares at current levels, because "I don't think there's going to be any positive

earning surprises for two or three quarters."

Should the stock fall back into the low 50s, "I'd be a buyer" again, Nabi continued. In the low-50s, Morgan's price-to-earnings ratio would be in the low teens, which is "not a fearful valuation," he said. Today, the stock trades at 14.8 times based on the current consensus it will earn $4.16 in 2001 and 12.7 times expected 2002 results of $4.86.

On the bright side, increased merger and acquisition activity because of the "current upheaval in the global economy" could emerge as a near-term catalyst to Morgan's results, Nabi mused.

That would certainly be a welcome event because net income in Morgan's securities business fell 37% in the first quarter as the firm's overall profits were down 30% from year-ago levels. (Overall first-quarter earnings bested expectations by a penny.)

More than the telco debt issue, "people are really concerned about the level of investment banking activity," S&P's Azarchs said. "If clients are going out of business, they no longer require services."

Aside from having a flair for the obvious, her point is that Morgan Stanley shareholders should now be more concerned about M&A than telecom debt. Those searching for an impetus for the Fed's rate cut also need to keep looking.

Aaron L. Task writes daily for In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task.