NEW YORK (Reuters) - Morgan Stanley MS.N agreed to sell a 21 percent stake to Japan's Mitsubishi UFJ Financial Group Inc 8306.T for $9 billion to shore up its finances, but investors balked at the deal's terms and helped send the investment bank's shares reeling.
“There appears no step that will instill confidence,” Fox-Pitt Kelton analyst David Trone told clients as news of the investment was greeted by a sharp drop in Morgan’s stock.
One week after revealing a preliminary agreement, Japan’s largest bank said Monday it would buy $3 billion of Morgan common stock at $25.25 a share, for a 9.9 percent stake in the company. The price is 19 percent below Morgan’s $31.25 book value on August 31.
The Japanese bank also will buy $6 billion of Morgan preferred stock paying a 10 percent dividend and convertible to common stock at a price of $31.25 a share. The weighted average of the deal values Morgan’s shares at $29, a 7 percent discount to book value.
Morgan shares were down $3.96 or 16 percent to $20.79 in afternoon trading on a day when the House of Representatives rejected a $700 billion bailout plan for the financial sector. Passage of the Troubled Asset Relief Program would have helped U.S. banks shed risky assets and make their balance sheets healthier.
Morgan Stanley Chief Executive John Mack called MUFG’s investment “a strong endorsement of Morgan Stanley’s world-class global franchise and future potential.”
Yet the deal also shows the worsening credit crunch is making even the world’s largest financial players more cautious about diving into the U.S. markets.
“These firms need to raise capital and reduce leverage to comply with new rules as bank holding companies,” S&P Equity Research analyst Matt Albrecht said. “Many foreign and private equity players have been burned by investments in financial firms, so you have to pay a premium to attract that capital.”
Toshihide Mizuno, senior managing director of MUFG, told reporters Monday that the bank was taking half its Morgan stake in preferred shares. A week earlier, Mitsubishi had considered buying a 20 percent stake in common stock, Mizuno said.
“But considering the current state of the economy and the market, we wanted to minimize and hedge our risk,” he said.
In one year, half the preferred stock would be convertible into common if Morgan’s stock traded for more than 150 percent of the conversion price for a specified period.
Morgan, the fifth-largest U.S. bank, said the investment would provide capital to pursue investment opportunities, bolster capital and increase its liquidity.
Including the Mitsubishi capital, Morgan would have a Tier One capital ratio of about 15 percent, among the highest in the banking industry. Morgan on Monday also said it had “significantly” reduced the leverage on its balance sheet since the end of August.
Analysts estimate Morgan would have about $15 of assets supported by each dollar of equity -- half the amount of leverage it used in February last year.
Yet the deal with MUFG failed to stop the erosion of its shares, after two weeks when investors and clients lost confidence in even the largest Wall Street banks.
“It appears the market felt Morgan Stanley didn’t do enough,” said Michael Santelli, a portfolio manager at Allegiant Asset Management in Cleveland. “Throughout this whole credit crisis, the biggest mistake banks have made is not getting enough capital when the window opened up.”
Earlier this month Morgan's shares fell by half as Lehman Brothers Holdings Inc LEHMQ.PK collapsed and ultimately filed for bankruptcy protection. Morgan Stanley scrambled to line up a merger partner and launched talks with MUFG. By September 21 it had abandoned its broker model to become a lower-risk bank.
The price of its debt-default insurance remained at distressed levels. Sellers demanded an upfront payment of 12 percent, or $1.2 million to protect $10 million of debt.
Last week Goldman Sachs Group Inc GS.N, which like Morgan converted to a bank structure, also scrambled to raise capital, though it came up with a different solution.
Within two days of converting to a bank, Goldman approached and struck a deal with Warren Buffett's Berkshire Hathaway Inc BRKa.N, which agreed to buy $5 billion of Goldman "perpetual" preferred stock paying a 10 percent dividend.
Buffett also received warrants to buy an additional $5 billion of stock at $115 per share, but there were no additional strategic business links with Goldman. Analysts said the deal would dilute Goldman shareholders by about 16 percent.
Markets lauded the news of Buffett’s stake, sending its shares up 6 percent and helping Goldman sell $5 billion of stock to the public at $123 per share. That was 1.24 times Goldman’s book value at the end of August.
Additional reporting by David Dolan in Tokyo; Editing by Gerald E. McCormick, Phil Berlowitz
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