Morgan Stanley Issues Bonds as Swaps Trail: Corporate Finance?

By Tim Catts and Mary Childs

April 27 (Bloomberg) -- Morgan Stanley is tapping the bond market for $4.5 billion as derivatives show traders perceive it to be the riskiest of Wall Street’s six biggest banks.

The firm sold $2.5 billion of 3.8 percent, five-year notes yesterday to yield 180 basis points more than similar-maturity Treasuries, according to data compiled by Bloomberg. In February, JPMorgan Chase & Co. issued $3 billion of notes due in 2016 that paid a 120 basis-point spread, while Goldman Sachs Group Inc. raised $2.5 billion of five-year debt that month at a 158 basis-point spread, Bloomberg data show.

Chief Executive Officer James Gorman, who took charge last year, is seeking to restore bondholder confidence by rejuvenating a fixed-income division that contributed to $23.4 billion of losses and writedowns during the financial crisis, eliminating dividend payments to Mitsubishi UFJ Financial Group Inc. and increasing profitability of its retail brokerage unit. While the cost to protect Morgan Stanley’s debt from losses has plunged in the past year, it remains higher than its peers.

“We’re still in a show-me situation as far as their risk management is concerned,” said Marc Beulke, an analyst at Minneapolis-based Thrivent Financial, which oversees $73.1 billion, including Morgan Stanley bonds. “It’s obvious it needed some improvement if you go back to 2008 and the losses they recorded compared with their competitors.”

Mark Lake, a Morgan Stanley spokesman, declined to comment.

Credit Swap Prices

While credit-default swaps tied to the debt of the New York-based bank have declined to 142.4 basis points from 307.5 basis points in June, they are still higher than Bank of America Corp., JPMorgan, Citigroup Inc., Wells Fargo & Co. and Goldman Sachs, according to data provider CMA.

The gap between contracts on Morgan Stanley and the average of the six biggest U.S. banks has shrunk to 31.7 basis points from as wide as 108.8 basis points in June. The difference was as narrow as 19.4 basis points in October, according to CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market.

Swaps on Morgan Stanley, the sixth-largest U.S. bank by assets, were trading at the same level as Bank of America Corp. as recently as March 2, when contracts on each cost 140 basis points. Those on Charlotte, North Carolina-based Bank of America have declined to 132.8 from 175.3 in June.

Contracts on Citigroup are priced at 122; those on San Francisco-based Wells Fargo cost 78.5 and swaps on JPMorgan, considered the most creditworthy of the banks, cost 74.3 basis points.

Implied Credit Rating

Even with the improvement, the price traders are paying to protect against losses in Morgan Stanley bonds implies a credit rating of Baa3, the lowest investment grade, compared with the company’s actual grade of A2, according to Moody’s Corp.’s capital market research group.

Credit swaps, which typically rise as investor confidence deteriorates and fall as it improves, pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Morgan Stanley’s bond sale, which included $2 billion of two-year floating-rate debt, came after it reported first- quarter net income last week of $968 million, or 50 cents a share, and adjusted earnings of 46 cents, which topped analysts’ average estimate of 40 cents. The securities pay 98 basis points more than the three-month London interbank offered rate, Bloomberg data show.

The bank issued $1.5 billion of five-year, 3.45 percent notes that paid a spread of 225 basis points in October, Bloomberg data show. That followed a $1.25 billion offering of 4 percent securities in July that paid a spread of 245 basis points, or 2.45 percentage points.

More Attractive

Morgan Stanley bonds are more attractive than those from firms including Bank of America and JPMorgan as yields on investment-grade debt decline, said Mirko Mikelic, a money manager at Fifth Third Asset Management, which oversees $17.7.

Investment-grade U.S. corporate bond yields fell to 3.91 percent on average yesterday, while bank bond yields are at 3.78 percent, both the lowest since November, according to Bank of America Merrill Lynch index data. Financial company debt yields have declined from 10.37 percent in March 2009.

“After we survived through ‘08 and ‘09, everyone’s kind of ridden the wave and is looking for spreads that are a little bit wider,” Mikelic, who’s based in Grand Rapids, Michigan, said in a telephone interview. “You want stuff like that.”

Morgan Stanley said last week it agreed to convert $7.8 billion of preferred shares held by Mitsubishi UFJ to common equity, paying a premium of about $2 billion to eliminate annual dividend payments of $784 million.

‘No. 1’ Priority

“This was frankly No. 1 on my list for this year,” Gorman said in an April 21 conference call with investors.

Morgan Stanley posted its first quarterly loss as a public company in the fourth quarter of 2007 as it wrote down mortgage holdings by $9.4 billion and took a $5 billion cash infusion from sovereign wealth fund China Investment Corp.

Morgan Stanley converted into a bank holding company in September 2008, after the bankruptcy of Lehman Brothers Holdings Inc. The firm borrowed as much as $97.3 billion from the Federal Reserve’s emergency lending programs that month. Over the next month, it received a $9 billion injection from Mitsubishi UFJ and agreed to take a $10 billion bailout from the U.S. Treasury.

“It will take some time before we have everybody as true believers,” Gorman said during a February investor conference, in response to why Morgan Stanley’s debt spreads are wider than competitors. “We’re getting further from the financial crisis, and we’re demonstrating that we’re not making new mistakes, which has been one of our mantras.”

Last quarter’s profit included a 26-cent loss tied to a joint venture with Mitsubishi UFJ.

“We view them as much more of a work in progress, as relatively new management figures out where they want to take the business,” said Joel Levington, managing director of corporate credit at Brookfield Investment Management Inc. in New York. “If one believes in the turnaround, it offers an opportunity.”

--With assistance from Michael J. Moore in New York. Editors: Pierre Paulden, Alan Goldstein

To contact the reporters on this story: Tim Catts in New York at tcatts1@bloomberg.net; Mary Childs in New York at mchilds5@bloomberg.net.

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net.

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