Wednesday, December 19, 2007

Morgan Stanley's kitchen sink

(WSJ MarketBeat) Perhaps the early pop in Morgan Stanley shares is attributable to one of those “sigh of relief” reactions, where what’s revealed is clearly so amazingly terrible that the firm can’t have anywhere else to go but up.

The investment bank took a $9.4 billion writedown, the second-largest such writedown to date, falling short of only the $10 billion UBS writedown the Swiss bank recently disclosed. Management “essentially kitchen-sinked the quarter,” notes David Trone of Fox-Pitt Cochran.

Of the $9.4 billion written down, $7.8 billion represents the firm’s subprime positions and represents a massive revaluing from the $3.7 billion in writedowns it estimated at the end of October. The firm had subprime exposure of $10.4 billion as of Aug. 31, the end of its third quarter, and now has $1.8 billion.

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Morgan Stanley shares have struggled all year.

If one takes that $10.4 billion and subtracts the $7.8 billion writedown, it leaves $2.6 billion, so that means the firm, in one way or another was able to reduce its subprime positions by an additional $800 million through a sale or something to get to that $1.8 billion. So working with a $9.6 billion figure, the $7.8 billion decline represents an 81.25% haircut on those assets, basically suggesting they’re completely worthless, or they’re perhaps reducing those asset prices by so much to benefit from a potential gain in the next few quarters if the prices rebound, if only a little.

“It appears that the firm wrote down its exposure to $0.25 on the dollar, which is the most aggressive mark we have seen thus far from any financial service firm,” note analysts at Goldman Sachs. “This would support our overall thesis that CDO write-offs in the industry will be more severe than estimated.”

Either way, it’s pretty ugly, even if CEO John Mack pinpointed it as “isolated losses by a small trading team.” While those losses may be isolated, it’s notable that on a sequential basis, commissions and asset management revenue was essentially flat, and investment-banking revenue declined. So while a $9.4 billion writedown can’t be expected again, deteriorating business trends can.

The firm also became the latest to sell an equity piece to a foreign owner, after a similar moves by Citigroup and Bear Stearns, to address capital issues. A total of $5 million in convertible shares were purchased by China Investment Corp., and represents about a 10% dilution as a result.

“What do you do when you’ve gambled away billions in idiotic mortgage bets? Run to China with your hand out,” writes Henry Blodget in Silicon Alley Insider. “What a disaster! Good thing one person at Morgan lost her job. And how nice of CEO John Mack, who accepts ‘full responsibility,’ to not take a bonus this year.”

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