Morgan Stanley to Post a Loss From Volatile, Complex Bonds

By AARON LUCCHETTI Morgan Stanley isn't in crisis mode anymore, but the Wall Street firm is still struggling to dig out of a slump. Adding to woes from real-estate and other basic businesses: The recent rebound in its bond prices, generally thought of as a positive, will actually hurt the company's bottom line. Because of the accounting treatment on some bonds issued by Morgan Stanley before the financial crisis erupted, the New York company is expected to take a hit of $1.2 billion to $1.7 billion on the bonds when it reports quarterly results later this month, according to people familiar with the situation. That is somewhat higher than the $500 million to $1 billion mark that many analysts are predicting Morgan would take from the bond-price move. View Full Image Bloomberg News John Mack, shown after last month's White House meeting, hasn't had a bonus since 2006. The bonds, valued at about $29 billion recently, rallied as Morgan Stanley distanced itself from fears last fall that it was in dire straits. However, the gains forced the firm to increase the paper value of bonds it owes to investors. Since Morgan Stanley adjusts its marks on these bonds as if they were being bought back on the open market, the more expensive liability flows to its bottom line, hurting earnings. While the hit reverses some of the gains Morgan Stanley got last year from the same securities, it could plunge the company into the red for the second quarter in a row. That hasn't happened in the 23 years since the firm went public. Analysts expect a seven-cent per share loss, down from a $1.45-a-share gain a year earlier. On Wednesday, two more analysts published reports predicting Morgan would lose money in the first quarter; its shares dropped 2.7%, or 63 cents, to $22.69, but they are still up 41% on the year. A Morgan spokeswoman declined to comment on the company's earnings. Ugly first-quarter results also would show how hard it is for Morgan Stanley to escape bets it made on real estate and leveraged loans when times were good. Write-downs on those assets are expected to total at least $1 billion in the latest quarter, casting a long shadow over Chairman and Chief Executive John Mack's continuing push to shed risky businesses and focus more on trading for the firm's clients. Taking fewer chances with trading also might have cost Morgan Stanley business in the first quarter, according to some analysts. And like other securities firms, Morgan Stanley still is dogged by a dismal climate for investment banking and asset management. The strains help explain why Mr. Mack is in no hurry to pay back the $10 billion in capital Morgan Stanley received from the federal government as part of the Troubled Asset Relief Program. In February, Mr. Mack told shareholders that the company's "intent is to pay it off as soon as it is feasible." On March 27, though, the CEO struck a different tone in a White House meeting, saying in an interview with The Wall Street Journal shortly afterward that a quick payback, while possible, would "undercut the purpose" of TARP. The first-quarter results, due the week of April 20, aren't expected to plunge Mr. Mack back into anything like the scramble he faced last September to shore up confidence in the firm. Since then, Morgan Stanley has sold a stake to Mitsubishi UFJ Financial Group Inc. and struck a joint-venture brokerage deal with Citigroup Inc., which could lift earnings in the long run. For now, though, Morgan Stanley's real-estate bets remain a daunting liability. In contrast, Goldman Sachs Group Inc., which has less real-estate exposure and is the only other major securities firm to survive 2008 as a stand-alone company, is expected to post roughly a 50% decline in per-share profit when it reports first-quarter results Tuesday. "In this quarter, the tide is in favor of Goldman Sachs and against Morgan Stanley," said Roger Freeman, a Barclays analyst. Goldman has more exposure to stocks, which rallied at the end of the quarter. Morgan Stanley is likely to suffer from its "heavy concentration" in real estate, Mr. Freeman said. The Barclays analyst predicts a first-quarter net loss of $1.4 billion at Morgan Stanley, including the hit from the firm's bonds. Morgan Stanley is more affected by changes in prices of its structured notes than other firms because it was a large issuer of those bonds, which give buyers an investment in stocks, commodities or other assets along with a Morgan Stanley debt instrument. Volatility in the bonds' pricing and yields resulted in a gain of more than $2 billion in the fourth quarter, even as Morgan Stanley was fending off speculation that it might collapse. The first-quarter loss on the bonds "is a relatively high-quality problem to have," Banc of America Securities-Merrill Lynch analyst Guy Moszkowski wrote in a recent note to clients. Diminished concerns about Morgan Stanley's bonds eventually should help lower the firm's borrowing costs and help its trading business. According to people familiar with the situation, Morgan Stanley is likely to mark down the value of its real-estate investments by a smaller amount than the bond adjustment. In the fourth quarter, the commercial real-estate fund in Morgan Stanley's investment-management division, called MSREF VI International, wrote down the value of its investments as much as 60%, according to a letter reviewed by the Journal. In June 2007, Morgan Stanley billed the venture as "the largest ever real-estate fund." It includes more than 20 office buildings in Germany. Meanwhile, investment banking, while somewhat better than in 2008 partly because of an improved performance in the merger-advisory business by Morgan Stanley, still is likely to be down 16% in revenue from last year's first quarter, estimates Brad Hintz, an analyst with Bernstein Research. Write to Aaron Lucchetti at aaron.lucchetti@wsj.com