Morgan Stanley got the $9 billion lifeline it needed from Mitsubishi UFJ Financial Group Inc., buying the investment bank more time to make over its balance sheet and sending its shares soaring 85% in late trading.
Stocks Today: Morgan Stanley Seals Deal
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Barron's Bob O'Brien says to give Morgan Stanley Credit because they locked in a $9 billion dollar deal with Mitsubishi ($7.8 billion preferred convertible position and $1.2 billion non-convertible position. (Oct. 13)
But Morgan Stanley Chief Executive John Mack still has a tough job ahead of him as he looks to continue transforming his business for a difficult environment.
One of the biggest changes -- the higher-risk trading businesses that carried Morgan for the past few years -- are going to get smaller, and the firm is going to rely more on building market share in lower-risk sales and trading, asset management and advising individual investors, while using its new relationship with MUFG to boost its presence in commercial banking.
"We've gotten our leverage down, and it will be even lower," Mr. Mack said in an interview. "You're going to see a lot of changes."
Mr. Mack said that his firm as well as a lot of hedge funds have been shrinking businesses that use a lot of leverage, such as complex securitized products and mortgages. Already, with the MUFG investment, Morgan Stanley has brought its ratio of leveraged bets to $20 for every dollar it has in equity. That's down from $32 a year ago.
The deal's structure gives MUFG a 21% stake in the company through convertible and perpetual preferred shares that pay a 10% dividend. That adds up to $900 million in new dividends for Morgan Stanley to pay annually to MUFG, which could dent future earnings.
Morgan Stanley had been scrambling to finish the MUFG investment amid a downward spiral of confidence, in which some investors were afraid the firm wouldn't survive if it couldn't close the deal. The two sides renegotiated some details of the deal over the weekend to reflect that Morgan Stanley shares had dropped below $10 from about $25 when the deal was announced on Sept. 29.
Morgan Stanley has argued that it is strong enough to survive and that its leverage has been brought down significantly, even before the MUFG investment. But with the stock falling sharply before this week, the capital injection was viewed as crucial in turning around the stock price. Mr. Mack also said that the firm's 8,500 brokers were especially happy to see the show of support. "It's all built on confidence," he said.
Indeed, the firm was so eager to get the deal completed that it moved up its timeline by a day to close the deal on Monday, a bank holiday, instead of Tuesday, as planned. To execute the deal on Columbus Day, MUFG early Monday had a check delivered to Morgan Stanley's headquarters in New York, rather than wiring the money, as would normally be the case, people familiar with the matter said.
Now Mr. Mack can turn back to expanding his business in a tough environment. The environment for deals has slowed down, the stock market has fallen sharply this year, despite Monday's gains, and the reduction in borrowed money will make big profits harder to achieve for many banks, including Morgan Stanley.
To make up for lost business, Mr. Mack plans to build up his firm's deposits, either through small acquisitions or possible joint ventures with MUFG, which is in discussions with Morgan Stanley about extending its relationship with a credit facility that could further boost Morgan Stanley's balance sheet. Mr. Mack says that both firms are "ready to move at a fast pace," after initially saying last month that it would move slowly on the joint venture.
Late last year, it became clear that Morgan and other banks would need capital to shore up their balance sheets, when trading losses and a sharp decline in the housing market forced many firms to write down the value of their assets. While Morgan Stanley has reduced its exposure to the hardest-hit parts of the mortgage market, it still has exposure to other economically sensitive sectors such as commercial real estate and high-yield loans to companies.
MUFG has been expanding its U.S. business, including the recent purchase of UnionBanCal Corp., a California bank that someday could fit into Morgan Stanley's own banking plans in the U.S. The lender, Japan's largest, and the second-largest bank globally by deposits, behind HSBC Holdings PLC, was the result of a 2005 merger between Mitsubishi Tokyo Financial Group and UFJ Holdings.
MUFG had grown nervous about completing a deal over the weekend, unless the U.S. government gave assurances that MUFG's investment wouldn't be wiped out by a future possible investment in Morgan Stanley by the U.S. government, a person familiar with the matter said. U.S. and Japanese government officials were involved in the talks to soothe those concerns, in part through a plan that would let the U.S. government buy up shares in companies only in a way that didn't wipe out the rights of previous big investors.
Morgan Stanley and MUFG have identified other areas for collaboration, including corporate and investment banking, certain areas of retail banking and asset management, as well as corporate lending and project related loans. MUFG will send one representative to sit on Morgan Stanley's board.
Morgan Stanley has been scrambling since its third-quarter earnings, released Sept. 16, failed to calm investors' nerves that it needed to sell off assets or raise more capital. The 73-year-old investment bank, formed by onetime J.P. Morgan & Co. partners after Depression-era legislation split commercial banking from investment banking, was forced to once again to return to its lending roots.
"We're in a much stronger position" after the deal, Mr. Mack said. "We have the firepower with the Mitsubishi relationship to go through almost anything that's thrown at us."
He complimented Mitsubishi management for sticking with the investment despite heavy outside pressure to walk away until the financial crisis in the U.S. abated. "It's not just a trade; it's a strategic relationship," he said. "They're honorable and smart and they see good value."
—Alison Tudor contributed to this article.
Write to Aaron Lucchetti at aaron.lucchetti@wsj.com
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