Morgan Stanley suffers another loss

The investment bank posts a big loss and cuts its dividend, but execs say the firm is healthy enough to repay TARP.

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By Colin Barr, senior writer

john_mack_2.03.jpg
A first-quarter loss shows CEO John Mack has much work to do at Morgan Stanley.

NEW YORK (Fortune) -- Morgan Stanley reported a much bigger-than-anticipated loss in the first quarter Wednesday, as the revenue at the bank's bread-and-butter equity sales and trading business plunged 74% from a year ago.

The firm was also hit by its exposure to the tanking commercial real estate market. But executives emphasized their market share gains in recent quarters, cited their strong capital ratios and said they would like to repay the money they received from the government last fall.

Morgan Stanley (MS, Fortune 500) shares dropped 3% in midday trading.

The Wall Street investment bank said it lost $177 million, or 57 cents per share, in the quarter ended March 31. Analysts were expecting a loss of 8 cents a share, according to Thomson Reuters.

Counting the payment of $401 million in preferred dividends, the bank reported a net loss to common shareholders of $578 million.

The company also slashed its quarterly dividend by 81%, to 5 cents from 27 cents, in a bid to conserve $1 billion in cash annually.

The latest results extend the firm's losing streak, and stand out from the rest of the major banks' earnings, which have been generally better than expected -- if sometimes of questionable quality. Last quarter, Morgan Stanley posted a $2.3 billion loss.

Nonetheless, finance chief Colm Kelleher said during a conference call that Morgan Stanley remains "uniquely positioned to benefit" from what he called the "profound cyclical and structural changes" in the economy and the financial markets.

Despite the latest quarterly loss, he said Morgan Stanley is "more than comfortable" with its capital cushion against future losses and would like to repay the $10 billion it got last fall from the Troubled Asset Relief Program.

"All we will say is we would like to repay TARP capital," he said. Some of the bank's biggest rivals, notably Goldman Sachs (GS, Fortune 500) and JPMorgan Chase (JPM, Fortune 500), have said they want to repay TARP funds.

Mixed bag

In a statement, CEO John Mack focused on strong performances in Morgan Stanley's fixed-income trading and investment banking businesses.

He said the bank was the top performer in the merger-and-acquisition rankings during the quarter, and like its peers made significant sums trading plain vanilla fixed income products in the interest rate, commodity and credit arenas.

But those gains were offset by $1 billion in losses on real estate investments, and $1.5 billion of lost revenue tied to changes in the value of the bank's liabilities.

Meanwhile, Morgan Stanley said revenue in its equity sales and trading group plunged to just $900 million from $3.4 billion a year earlier.

Those setbacks help to explain part of the huge decline in Morgan Stanley's first-quarter revenue, which plunged 62% from a year ago to $3 billion.

The commercial real estate loss is particularly notable, for analysts have been warning that big banks could take a big hit this year in that once-hot market.

Goldman Sachs analysts wrote earlier this year that they expect commercial real estate to be the biggest problem asset class for banks in 2009. Analyst James Fotheringham forecast a 21%-26% price decline, which he said would lead to tens of billions of dollars of loan losses for banks and brokerage houses.

The results and the dividend cut reflect a decline in the profitability of Morgan's core business. Still, Morgan Stanley's capital ratios remain strong - the bank said its Tier 1 capital, a measure favored by regulators, is 16%, and its Tier 1 capital excluding the $10 billion it got last fall under the Treasury's Troubled Asset Relief Program is 13%.

Regulators consider a bank with 6% Tier 1 capital well capitalized.

Good news, bad news

Mack also said the latest-quarter loss was partly attributable to something that would normally count as good news.

He said Morgan Stanley would actually have reported a first-quarter profit if not for "the dramatic improvement in our credit spreads -- which is a significant positive development."

Tighter credit spreads reflect reduced investor anxiety over the prospect that the company might default on its obligations, and result in lower borrowing costs for the company.

But they also obligate the company to write up the value of those liabilities, in light of the increased amount Morgan Stanley would have to pay to repurchase those debts.

Kelleher told investors on the conference call that the bank would have made 37 cents a share in the first quarter if not for lost revenue tied to the credit spread improvement.

In last year's first quarter, Morgan Stanley posted $1 billion in gains by writing down the value of its obligations as credit spreads widened.

The disappointing first-quarter report comes as investors puzzle over what course Mack will chart in the coming year. Like Goldman, Morgan Stanley became a Federal Reserve-regulated bank holding company last year to ease worries about its access to funding.

Unlike Goldman, which has said it intends to stay focused on its investment business, Mack has said Morgan Stanley might seek to buy a regional bank to expand its deposit base.

Kelleher said Wednesday that Morgan Stanley is looking to make acquisitions that would expand its high-net-worth customer base, rather than ones that would bring it a big loan portfolio.

Morgan Stanley said deposits rose 67% in the latest quarter, while total assets fell 45% from a year ago to $626 billion, reflecting a continuing focus on deleveraging.

Kelleher added that Morgan, like Goldman, held a huge cash balance in the first quarter, in the name of prudence. He said the bank's liquidity position during the quarter amounted to $152 billion and represented nearly a quarter of its balance sheet. To top of page

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