Morgan Stanley pays high cost for funding

By Dan Wilchins

NEW YORK, Dec 19 (Reuters) - Morgan Stanley managed to secure funding from a deep pocketed sovereign fund at a rate comparable to what Citigroup is paying in a similar deal, but the price is still high, analysts and convertible bond experts said.

The investment bank said on Wednesday that it was selling up to 9.9 percent of itself to China's foreign exchange fund for about $5 billion, using securities known as mandatory convertibles. Those securities pay 9 percent a year to the investors until they convert to shares in August 2010.

That 9 percent a year translates to about $450 million of cash out the door next year, equal to about 18 percent of this fiscal year's earnings.

It also means that in about 2-1/2 years, Morgan Stanley will have to issue a large chunk of new stock, diluting current shareholders.

Investors cheered the move, in part because the new capital will shore up Morgan Stanley's balance sheet. The company's shares rose 4.2 percent on Wednesday, after the investment bank said it wrote down $9.4 billion, an amount equal to about a quarter of its third-quarter equity of $35 billion.

"It's a strange world we live in where dilutive capital raising is considered a positive by the market," said James Ellman, portfolio manager at hedge fund Seacliff Capital.

In August 2010, the $5 billion face value of the securities will buy Morgan Stanley shares at a 20 percent premium to a reference level, which is expected to be some variation on Morgan Stanley's share price this week.