Morgan Stanley staying in its shell, CFO says

By Joseph A. Giannone

NEW YORK (Reuters) - Morgan Stanley (MS.N) remains wary of volatile markets, reducing trading risk as it waits for opportunities for a rebound from recent mortgage and leverage lending losses, Chief Financial Officer Colm Kelleher told Reuters on Wednesday.

"This has been an unusually stressed quarter. You only have to see how other people performed to realize you can swing the bat or retreat into your shell. I think we have done the prudent thing here," Kelleher said, shortly after the firm announced a 57 percent drop in second-quarter earnings.

Fixed-income sales and trading revenue plunged 85 percent to $414 million, driven by declines from its interest rate, credit and currency businesses. Kelleher attributed much of the decline to lower client activity, although losses from wrong-way bets on mortgages and energy commodities further dragged on results.

"We took contrarian bets in the energy sector. We felt it was the right trade. It didn't work. Sometimes that happens," Kelleher said.

Morgan Stanley has been hard-hit by the breakdown across a number of financial markets, notably massive losses on mortgage securities. Since the end of last year, the second-largest U.S. investment bank has told investors it would "stay close to shore" until the market environment improved.

Average daily value-at-risk from trading rose to $99 million from $97 billion, but that rise mostly reflects the extreme volatility in a period that drove Bear Stearns out of business in March.

"We just did not think this was a quarter to take risk bets," Kelleher said. "The opportunities have not been there on a risk-adjusted basis."

Morgan Stanley instead has been shoring up its balance sheet and boosting cash balances. Total liquidity rose to $135 billion, while the firm issued $22.9 billion of debt this year. During the quarter, Morgan realized $1.43 billion of pretax gains from asset and stake sales.

And like its rivals, Morgan has been slimming down the balance sheet. Total assets fell by $60 billion, or about 5 percent, from the first quarter to $1.03 trillion.

In particular, the bank reduced residential mortgage exposure by more than $2 billion to $12.3 billion, net commercial mortgage exposure sank to $6.4 billion, and leverage finance stood at $12.7 billion, down from $35 billion at its peak last August.

"We reduced our exposures. Subprime mortgages are almost gone," he said.

As a result of these moves, Morgan's leverage ratio has narrowed to 25 times equity at the end of May, compared with 32 times last August.

Yet Kelleher indicated the firm was largely done reducing leverage, one measure of a firm's financial strength, and will consider again boosting assets should trading and investment opportunities arise.

"We're in the zone," he said.

(Editing by Gerald E. McCormick)