Morgan Stanley seen $1.8 billion short, to issue stock

NEW YORK (Reuters) - Morgan Stanley said on Thursday it would sell $5 billion in common stock and bonds not backed by the FDIC after the U.S. government stress test determined the investment bank needed to boost capital by $1.8 billion.

The investment bank said it had commenced a public offering for $2 billion of common shares.

It also said it intended to sell $3 billion of senior notes that would not be guaranteed by the U.S. Federal Deposit Insurance Corp (FDIC).

The announcement came as the government announced results of how much more capital the 19 largest U.S. banks need to survive a severe financial downturn.

Morgan Stanley shares fell 4.8 percent to $27.14 in the regular session of the New York Stock Exchange on Thursday, and another 6 percent in after-hours trading.

Before this decline, the stock had soared 77 percent this year on rising optimism that the worst was behind the bank.

Earlier on Thursday, people familiar with the situation told Reuters that Morgan Stanley had been told to boost capital by about $1.5 billion. The increase, these people said, was in connection with the bank's pending deal to take control of Citigroup's Smith Barney brokerage unit.

That is a modest amount compared with the $34 billion increase reportedly mandated for Bank of America Corp, the largest U.S. bank by assets.

The Smith Barney deal calls for Morgan Stanley to pay Citigroup $2.7 billion in cash for majority control of a venture combining the brokerages of the two banks. That money would reduce Morgan Stanley's tangible common equity, a key measure of balance sheet strength.

The joint venture deal is expected to be completed by the third quarter.

Morgan Stanley declined to comment, noting banks are not authorized to discuss the stress test results until the government makes its announcement.

Under the Smith Barney agreement, Morgan Stanley would contribute wealth management businesses and cash for a controlling 51 percent stake.

Morgan Stanley, which has the right to increase its stake to 100 percent in later years, would run the largest U.S. brokerage and a business expected to accelerate earnings.

DEFAULTS

Morgan Stanley said in its quarterly financial results filing on Thursday that it ended March with a Tier 1 capital ratio of 16.7 percent, up from 16.4 percent announced last month.

Since the end of 2007, Morgan has slashed the size of its balance sheet, reduced total assets to 11.2 times equity and boosted liquidity reserves to $152 billion. Hard-to-value "Level 3" financial assets were 26 percent of total financial assets, down from 30 percent in the fourth quarter of 2008.

That same filing also disclosed that unidentified Morgan Stanley units on March 31 were in default of some non-recourse financing agreements after they breached non-monetary loan covenants.

The bank said it had obtained from lenders limited waivers that expire at the end of this month, and it was working with lenders toward a longer-term solution.

Disclosures elsewhere in the 10-Q filing indicated that the defaults may involve Morgan's holdings in Crescent Real Estate, a real estate investment firm acquired in August 2007 for $6.5 billion, or consolidated interests in private investments.

At the end of March, Morgan valued its Crescent and other consolidated interests at $3.7 billion. These assets are subject to non-recourse debt of $2.5 billion provided by outside lenders, Morgan Stanley said in the filing.

Crescent has been a source of losses as real estate values plunged. Morgan recorded a $131 million first-quarter impairment charge and a $243 million fourth-quarter charge.

(Reporting by Joseph A. Giannone, editing by Gerald E. McCormick)