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Investor Fear Over Morgan Stanley Sharpens

Morgan Stanley
Gregory Bull
Morgan Stanley

It is Morgan Stanley’s turn on the hot seat.

As confidence in the soundness of some of the world’s biggest banks has fallen in recent weeks, investors have been selling off their shares of one financial institution after another.

Now, the fears about Morgan Stanley are becoming especially acute. Investors are worried about the bank’s exposure to the European debt crisis, its ability to weather a turbulent trading environment and its reliance on short-term borrowing to finance its operations.

The bank and some analysts say the fears are unfounded. But the market drove Morgan Stanley shares down 10.5 percent on Friday to $13.51, and the stock has lost 41 percent in the last three months. That performance was par for the course in what was a bruising third quarter for the entire financial industry. Bank of America shares fell more than 44 percent. Citigroup shares dropped more than 38 percent, while even Goldman Sachs , considered the mightiest of the Wall Street giants, tumbled more than 28 percent.

It was also a brutal quarter for the broader stock market. The Standard & Poor’s 500-stock index fell 14 percent from July to September, its worst performance since the fourth quarter of 2008 at the height of the financial crisis.

Almost everywhere they looked, investors saw trouble. In the United States, the Congressional deadlock over debt and the downgrade of the nation’s once-sterling credit rating rocked the confidence of consumers and businesses. In Europe, rising concerns about a potential Greek default and the inability of other governments to agree on a financial rescue plan surged through the markets. Grim data also pointed to a sharp slowdown in economic growth around the globe.

Now Morgan Stanley, which never regained the prestige and power it had in the years before the 2008 crisis, is quickly becoming a focal point for investors who fear that it may not be able to weather another financial storm

In another closely watched indicator of investor sentiment, the cost of buying protection against a default of Morgan Stanley bonds has soared. It now eclipses the cost of similar insurance on major French banks. Only a few weeks ago, the French banks came under heavy fire amid concerns that they were struggling to finance their operations.

Investors are now paying $449,000 a year to insure $10 million of Morgan Stanley bonds against a possible default in a sparsely traded market in what are called credit-default swaps . That is almost three times the cost in early June, but it is still well below the roughly $1.3 million a year it cost to insure Morgan Stanley bonds a few weeks after the collapse of Lehman Brothers, according to pricing from Markit.

Among investors, the concerns are many. Some worry that the test could come from the company’s exposure to French banks. Others fear a liquidity crisis similar to what occurred in 2008 when banks like Morgan Stanley struggled to borrow the short-term debt that keeps them afloat. Still other investors expect the turbulent markets to take their toll on trading and investment banking results, which are the lifeblood of Wall Street.

“It strikes me that everything seems to be O.K. with these guys,” said Brad Hintz, an analyst at Sanford C. Bernstein & Company, who is a former treasurer at Morgan Stanley. “I’m not arguing that we’re not seeing stuff in the credit-default swaps market that is pretty scary-looking. But they just don’t seem to be having any problems funding themselves.”

Some investors worry that Morgan Stanley may be too reliant on short-term borrowing or that it lacks a significant deposit base like those of the large commercial banks JPMorgan Chase or Bank of America. Others, however, note that Morgan Stanley has shifted much of its borrowing into longer-dated paper since 2006 and that its deposits have risen to $66 billion, from $28 billion.

Citing the quiet period before Morgan Stanley reports third-quarter earnings, a spokeswoman for the company declined to comment.

In recent weeks, analysts and investors have scoured obscure regulatory filings and reports, trying to determine what potential exposure Wall Street banks could have to troubled regions and institutions in Europe.

One filing that quickly gained attention in the market revealed that Morgan Stanley had one of the biggest exposures among Wall Street companies to the ailing French banks — about $39 billion at the end of last year, before factoring in offsetting hedges and collateral. Morgan Stanley has not provided investors with more up-to-date information.

But in a research note, Mr. Hintz said that Morgan Stanley had substantially reduced its exposure to French banks and estimated that it was now likely to be less than $2 billion, after factoring in collateral and hedges.

Investors also expect Morgan Stanley to report lackluster trading results, in line with many of its peers who have seen a slowdown in activity as clients have moved into cash.

After several periods of lackluster results, Morgan Stanley’s trading desks had a standout performance in the second quarter — besting even Goldman in challenging markets. Morgan Stanley’s financial statements showed that it was increasing its appetite for risk.

Now, some investors worry that Morgan Stanley may have turned too aggressive at just the wrong time. They are now girding for another round of dismal results — especially after JPMorgan warned in mid-September that its trading revenue could fall almost 10 percent from a year ago and now that Wall Street analysts expect Goldman to report a loss in the quarter.