Accepting market reality
For Morgan Stanley, the past year has been truly transformational. Amid a credit crisis that would subsume rivals, the bank weathered a loss of investor confidence that jeopardised its own survival. Throughout it sourced liquidity wherever possible – government investment, strategic equity, joint ventures – and sought to limit risks by reducing leverage and reigning in risks. Stephen Lacey reports.
Few financial institutions benefited as much from government programmes designed to resuscitate the banking system as Morgan Stanley. In May 2008, the bank raised US$6bn through a three-part sale of debt: US$2bn re-opening of its 2018 notes, offered at T+240bp; US$2bn re-opening of 2015 notes, at 287.5bp over; and a new, two-year floater at 210bp over three-month Libor.
It would be a full year before Morgan Stanley would rely upon its own balance sheet to issue debt. In May 2009, the bank raised US$5.5bn from the sale of five- and ten-year debt at initial yields of 6.08% and 7.33%, respectively. The financing was originally sized at US$2bn but was increased at pricing and re-opened later that month amid strong investor demand. The sale paved the way for the repayment in June 2009 of the US$10bn received under the US government’s troubled asset relief programme.
For much of the prior year, Morgan Stanley relied heavily on government programmes to manage its liabilities. Few institutions relied so heavily on the government’s temporary liquidity guarantee programme, whereby the US government guaranteed short-term debt (December 31 2012) issued between October 2008 and October 2009.
Between November and March 2009, the bank issued a total US$23.5bn of TLGP debt. That was the fourth-highest total of the 19-stress tested organisations with more than US$100bn in total assets and the second-highest as a percentage of total assets, at 3.6% as of December 31. Only Bank of America (US$41.5bn), Citigroup (US$39.5bn) and JP Morgan (US$34.5bn) issued more under the programme. American Express (US$5.9bn) was the sole issuer with a larger percentage, at 4.7% of total assets.
“The availability of insurance opened up the investor base to participate in refinancing of our corporate debt,” said Dan Park, managing director within treasury at Morgan Stanley. “From our perspective it certainly was a competitive cost of funds, which was the point of the programme for industry as a whole.”
To smooth maturities, the bank sold TLGP debt with various tenors of one-, two-, and three-years, as well as a mixture of floating- and fixed-rate securities. Its inaugural TLGP issuance in November came as a one-year, US$2.25bn and a two-year, US$2.5bn fixed-rate note that priced at yields of 2.93% and 3.26%, 180bp and 186bp over Treasuries.
By March, the cost of TLGP debt had fallen to 87.4bp over on a US$2bn, three-year offering and to 3-month Libor plus 20bp on a three-year, US$3bn floater, reflecting renewed confidence in the issuer.
Although FDIC prohibits the use TLGP to repurchase debt, Morgan Stanley used alternative sources of liquidity to repurchase debt at discount. In the fourth quarter, when its five-year credit protection blew out to L+1,350bp and client flows were largely unidirectional, the bank repurchased US$12.4bn of its debt at discounts, resulting in gains of US$2.3bn for the quarter.
“Given the market dynamic, we took the opportunity to repurchase US$12.4bn of firm issued debt,” said CFO Colm Kelleher on the firm’s fourth-quarter earnings call in December.
Significantly, the bank began to accelerate asset rationalisation in the fourth quarter by reducing balance sheet intensive businesses such as prime brokerage, proprietary trading, and exiting its residential mortgage originations. The quarter also marked a significant strategic shift: along with Goldman Sachs, it chose to be regulated as a bank holding company, giving it access to the Fed discount window but putting an end to the era of standalone investment banks.
Mitsubishi UFJ’s US$9bn investment in October provided a vote of confidence that advanced de-leveraging initiatives, though it would not be immediately apparent. Suspecting the worst, investors sent Morgan Stanley shares skidding from US$24.04 prior to the announcement to US$9.40 at closing in mid-October –coinciding with L+1350bp CDS. To its credit, the Japanese bank remained committed to the investment, structured in the form of US$7.8bn of convertible preferred with a base conversion price of US$25.25.
Morgan Stanley’s more conservative stance is evident in the size and composition of its balance sheet. By March 31, total assets had declined to US$626bn, from US$676.7bn at year-end 2008 and roughly half the US$1.1trn at the end of fiscal (November) 2006. Gross leverage fell to about 11-times at year-end 2008 from a peak of over 30-times at the end of 2007. These metrics put it more in line with commercial banks than investment banks.