Mitsubishi pumps $11b into Morgan Stanley for stake

Morgan Stanley agreed to sell a 21% stake to Japan's Mitsubishi UFJ Financial Group Inc. for $US9 billion ($11 billion), seeking to shore up investor confidence after borrowing costs climbed and its stock fell by half.

Mitsubishi UFJ, Japan's biggest lender, will buy $US3 billion of common stock and $US6 billion of convertible preferred stock that pays a 10% dividend, the two companies said today in a statement. Morgan Stanley shares fell 15% amid a collapse in bank stocks after a $US700 billion financial-rescue bill failed to pass in Congress today and Wachovia Corp. sold most of its assets to Citigroup Inc.

Morgan Stanley Chief Executive Officer John Mack is raising capital, seeking to boost deposits and transforming the second- biggest US securities firm into the fifth-biggest bank-holding company after investors lost confidence in firms that depend on bond markets for financing. Mitsubishi UFJ has reported about $US1.3 billion in credit-market losses and writedowns since last year, compared with $US15.7 billion at Morgan Stanley.

``I don't know if they really need the capital now, it's more perception in the market that they should get that capital,'' said Peter Kovalski, who helps oversee $US12 billion at Alpine Woods Capital Investors LLC and owns Morgan Stanley stock.

Even with the new capital, Morgan Stanley dropped $US3.76 to $US20.99 in New York Stock Exchange composite trading, extending its decline this year to 60%. Earlier today the stock traded as low as $US19.14.

Rescue fails

The US House of Representatives voted 228 to 205 to reject a $US700 billion financial-rescue package crafted over the weekend by leaders of the House and Senate. The legislation would have given Treasury Secretary Henry Paulson broad authority to buy troubled assets from financial companies.

The vote added to concern about financial stocks, which had already fallen around the world after European governments stepped in over the weekend to rescue Fortis, Bradford & Bingley Plc and Hypo Real Estate Holding AG and after Citigroup bought Wachovia's banking assets in a deal brokered by the Federal Deposit Insurance Corp. The 85-member S&P 500 Financials Index dropped about 10%.

Mitsubishi UFJ agreed to buy 9.9% of Morgan Stanley's common stock for $US25.25 per share, 2% more than Morgan Stanley's closing price of $US24.75 on Sept. 26. Mitsubishi UFJ's $US6 billion of preferred stock will convert at a price of $US31.25 a share, according to the statement.

Mitsubishi's loss

At today's closing price of $US20.99, Mitsubishi UFJ has already lost $US4.26 on each Morgan Stanley common share it's acquiring, or about $US506 million in total.

Mitsubishi UFJ will get a seat on Morgan Stanley's board. After one year, half of the preferred stock automatically converts into common shares when Morgan Stanley trades above 150% of the conversion price for a certain period. The other half converts on the same basis after two years.

The transaction differs from a ``letter of intent'' to pursue an alliance the two companies announced on Sept. 22. In that agreement, Tokyo-based Mitsubishi UFJ planned to acquire 10% to 20% of New York-based Morgan Stanley for about 900 billion yen ($US8.5 billion).

The bankruptcy of Lehman Brothers Holdings Inc. on Sept. 15 has increased investor concern about deteriorating asset values and leverage, or the ratio of assets to shareholder equity, at Morgan Stanley and larger rival Goldman Sachs Group Inc.

`Huge' premiums

``There appears to be no step that will instill confidence,'' David Trone, an analyst at Fox-Pitt, Kelton Cochran Caronia Waller wrote in a note to investors today. ``With Lehman's demise, debt investors are requiring huge risk premiums for brokers, even though the problem asset risk is much lower for Morgan Stanley, in our view.''

Trone cut his fourth-quarter earnings estimate for Morgan Stanley to 83 cents per share from a prior forecast of $US1.03 to reflect the dilution from the Mitsubishi UFJ investment.

``Mitsubishi is definitely in the driving seat in stipulating the terms it wants with Morgan Stanley,'' said Amir Anvarzadeh, director of Japanese equity sales at KBC Financial Products in London.

On Sept. 18, Morgan Stanley fell as low as $US11.70 and its credit-default swaps, or the cost of insurance against a bond default, rose to a record before declining on news about a proposed US government financial rescue package. Within days, both Morgan Stanley and Goldman won approval from the Federal Reserve to change into bank-holding companies, expanding their ability to borrow from the Fed and allowing them to account differently for some of their assets.

Buffett and Goldman

Goldman, the biggest and most profitable US securities firm before becoming the fourth-biggest bank-holding company by assets, raised $US5 billion from Warren Buffett's Berkshire Hathaway Inc. on Sept. 23 and an additional $US5 billion from a public offering.

In return for the investment, Buffett was granted a 10% dividend and warrants to purchase $US5 billion of common stock at a discount to the market price, terms called ``extraordinarily expensive'' for Goldman by Meredith Whitney, an analyst at Oppenheimer & Co.

That heightened speculation that Mitsubishi UFJ might seek to renegotiate the terms of its Morgan Stanley investment. Mack, 63, sent employees a memo on Sept. 26 assuring them that the Mitsubishi UFJ deal was ``moving ahead as anticipated.''

`Important deal'

``It's an important deal'' for Morgan Stanley, said Steve Roukis, who helps oversee $US1.4 billion, including Morgan Stanley stock, as managing director of Matrix Asset Advisors Inc. ``It helps them facilitate their move from being an investment bank to a commercial bank, and it gives them another equity investor in Asia, where a lot of the deals will be sourced going forward.''

Morgan Stanley, which hired former US Comptroller of the Currency Eugene Ludwig last week as an adviser on its transformation into a bank-holding company, has teams working ``to explore the most attractive opportunities offered by this new structure,'' Mack said in the memo.

With $US9 billion of new equity from Mitsubishi UFJ, Morgan Stanley's leverage ratio would drop to 22.1-to-1 from 27.6-to-1 at the end of August. The leverage ratio measures the amount of assets held with each $US1 of shareholder equity, with higher numbers reflecting greater reliance on borrowing. Morgan Stanley had $US988.8 billion of assets at the end of August.

Tier 1 ratio

Morgan Stanley's Tier 1 ratio, which measures capital based on the risk of a bank's assets, will jump to 15% from about 12.7% at the end of August when measured using the new Basel 2 accounting standard, according to Susan Roth Katzke, an analyst at Credit Suisse Group AG. Based on the previous Basel 1 standard still used by most banks, the Tier 1 capital ratio will climb to about 14%, said Mark Lake, a spokesman for Morgan Stanley. Banks are required to have a Tier 1 ratio of at least 6% to be deemed ``well capitalized.''

With $US10 billion of capital raised, Goldman's leverage ratio dropped to 19.4-to-1 from 23.70-to-1 at the end of August. Goldman held $US1.08 trillion of assets at the end of last month.

Mitsubishi UFJ, formed in October 2005 after a merger between Mitsubishi Tokyo Financial Group Inc. and UFJ Holdings Inc., reported a 66% decline in first-quarter profit to 51.2 billion yen on Aug. 5 as bad-loan costs rose and income from investment sales declined.

The Japanese lender today completed its offer to take control of San Francisco-based UnionBanCal Corp. for about $US3.5 billion. Mitsubishi UFJ also is raising its stake in Japanese consumer lender Acom Co. to 40% from 16% for about $US1.4 billion.

Japanese writedowns

Japanese companies account for less than 3% of the more than $US585 billion in markdowns and losses by global banks following the collapse of the US subprime mortgage market last year.

``The financial turmoil is likely to wake people up to how well Japanese banks are capitalized,'' said KBC Financial's Anvarzadeh.

Nomura Holdings Inc., Japan's biggest brokerage, agreed this month to buy Lehman's Asian and European operations for less than a month's revenue after the fourth-largest US securities firm filed for bankruptcy, the biggest in US history.

Lazard Freres & Co., a unit of Lazard Ltd., provided financial advice to Mitsubishi UFJ. BlackRock Inc. advised Mitsubishi UFJ on asset valuations.

Bloomberg News