China takes 10% stake in Morgan Stanley to cover junk mortgages

Section:

Morgan Stanley Sells Stake to China Amid Losses

By Joseph A. Giannone
Reuters
Wednesday, December 19, 2007

http://www.reuters.com/article/ousiv/idUSWNAS491120071219

NEW YORK (Reuters) - China agreed to pump $5 billion into Morgan Stanley as the U.S. investment bank reported a stunning fourth-quarter loss fueled by a bigger-than-expected $9.4 billion of write-downs in mortgages and other assets.

China's investment, which could translate into as much as a 9.9 percent stake in Morgan Stanley, marks the latest capital infusion by a sovereign wealth fund into a major U.S. bank hurt by this year's credit crunch.

Morgan Stanley's shares rose more than 3 percent as investors hoped the large write-downs may be a sign of the beginning of the end of the subprime mess.

"A lot of people feel maybe the worst is behind us, and there is going to be tremendous value to obtain in this sector. I think a lot of that feeling is misguided. No one truly knows how much risk they have left," said Matt McCormick, portfolio manager at Bahl & Gaynor Investment Counsel in Cincinnati, which does not own Morgan Stanley shares.

Last month, Morgan Stanley said that traders betting the bank's own capital had incurred $3.7 billion in losses on U.S. subprime mortgages. On Wednesday the bank disclosed it took an additional $5.7 billion in write-downs, reflecting further deterioration in mortgages and losses on other debt.

To restore its capital, Morgan agreed to sell about $5 billion of equity units that pay a 9 percent coupon and are convertible into as much as 9.9 percent of Morgan's shares. China Investment will be a passive investor and have no role on the board or its management.

With the write-downs knocking down earnings by $5.80 a share, the second-largest investment bank posted a net loss from continuing operations of $3.59 billion, or $3.61 a share, in the quarter ended November 30. A year earlier Morgan had income from continuing operations of $1.98 billion, or $1.87 a share.

Morgan Stanley's operating results reflect the spin-off of Discover Financial Services in July.

Analysts had expected Morgan Stanley to post a loss of 39 cents per share, according to Reuters Research.

"The write-down Morgan Stanley took this quarter is deeply disappointing to me," Morgan Stanley Chief Executive John Mack said in a statement. "Ultimately accountability for our results rests with me." Mack said he would not accept a bonus this year.

Morgan Stanley's results come a day after Goldman Sachs reported a 2 percent profit increase, beating estimates as its fixed income traders sidestepped the problems that snagged the rest of Wall Street. Lehman Brothers Holdings Corp. last week reported a 12 percent decline in earnings, due mostly to $3.5 billion in gross write-downs.

Morgan said $7.8 billion of the write-downs came from U.S. subprime trading positions, which fell further since the bank's November 7 warning. Morgan also wrote down $1.6 billion of other debt, such as commercial mortgages, Alt-A mortgages and other loans.

The bank's remaining direct net exposure to U.S. subprime mortgages was $1.8 billion on November 30, down from $10.4 billion at the end of August.

"The fact that there's only $1.8 billion left in subprime exposure suggests they are getting to the end. There's also the cash infusion." said Steve Goldman, market strategist at Weeden & Co. in Greenwich, Connecticut. "There's the write-down, but they got it back through some (new) capital. The net result is a dilution for shareholders."

The China deal reinforces Morgan Stanley's ties to the vast, rapidly growing market in the Asian nation. More than a decade ago, then-President Mack helped forge the China International Capital Corp investment banking venture, in which Morgan owns about a one-third stake.

China Investment will convert its units into Morgan Stanley shares in 2010, at a price 20 percent above a level to be set this week.

Other banks have turned to sovereign funds for investments in recent weeks. Citigroup last month said it was selling up to 4.9 percent of itself to the Gulf Arab emirate of Abu Dhabi for $7.5 billion, and Bear Stearns in October swapped a stake in itself for a stake in China's CITIC Securities Co.

For the quarter, Morgan Stanley net revenue was a negative $450 million, compared with $7.85 billion last year.

The losses are a big setback for Mack, widely revered by investors since he replaced Philip Purcell as CEO in 2005. Mack directed the bank to take on more risk and expand businesses such as mortgages and leveraged lending to close the bank's performance gap with Goldman Sachs Group, the world's largest security firm by market value.

Earlier this year those efforts were paying off, as Morgan reported a mortgage trading profit even as subprime markets started to falter. Yet that trade, which bet against mortgages, went awry as the market worsened beyond what Morgan Stanley's traders had expected.

The big losses came from Morgan Stanley's institutional securities unit, which posted a pre-tax loss of $6.5 billion, compared with $2.2 billion of pre-tax income in the fourth quarter of 2006. The banking and trading unit posted record advisory revenue of $779 million.

But other units turned in profits. Global wealth management, the brokerage unit, posted $378 million of pre-tax income, compared with $169 million in the same quarter last year. Asset management generated $294 million of pre-tax income, compared with $268 million in the same quarter last year.

Shares of Morgan Stanley have tumbled 29 percent during the past two months as the mortgage trade backfired and delivered losses. The trading losses prompted Morgan Stanley to oust co-President Zoe Cruz last month and shake up its fixed income and risk management leadership.

Shares of Morgan Stanley were up $1.50 to $49.57 in morning trading on the New York Stock Exchange.

* * *

Join GATA here:

Vancouver Resource Investment Conference
Sunday-Monday, January 20-21,2008
Vancouver, British Columbia, Canada
http://www.cambridgeconferences.com/

* * *

Reserve the dates:

The next GATA conference
Friday and Saturday, April 18 and 19, 2008
Maybe "Gold Rush 21-08 -- Anybody Seen Our Gold"?
Washington, D.C., area

* * *

Help Keep GATA Going

GATA is a civil rights and educational organization based in the United States and tax-exempt under the U.S. Internal Revenue Code. Its e-mail dispatches are free, and you can subscribe at http://www.gata.org/.

GATA is grateful for financial contributions, which are federally tax-deductible in the United States.