Morgan Stanley on Subprime (Still Hurting), Real Estate and More

Key quotes from Morgan Stanley's (MS) FQ408 conference call:

Subprime; where it all began, and where it still is:

Extreme levels of negative sentiment are priced broadly across the credit market spectrum including the investment grade, loans and the ABX subprime index... The CMBX AAA index as a benchmark currently implies an... unprecedented cumulative default rate of greater than 60% over the duration of the underlying bonds assuming 100% loss severity.

Within the ABS CVO subprime schedule you can see our total net exposure was slightly net short. Of note on this schedule is the reduction of our super senior legacy mezzanine positions from $1.1 billion to zero which was accomplished with minimal P&L impact.

Within non-sub prime residential mortgage we reduced our gross and net exposures by roughly 20%. These exposures include alt-A which declined 27%. Overall net write downs were $900 million including $650 million in alt-A.

Commercial loans:

Within CMBS commercial whole loans we reduced our gross exposure to $17 billion driven by nearly 40% reduction in CMBS bonds. Net exposure declined over 60% to $2.9 billion. Overall here we recorded a net gain of $200 million.

CMBS bonds in the third quarter of 2008 we have in the low 70’s. We now have them in the high 40’s. Senior commercial loans were high 80’s to low 90’s are now being marked down as well to the high 80’s. Mezz, mid 70’s to low 60’s. There is Mezz commercial loans, alt-A mid 30’s to high 20’s. We have actually taken some very significant marks here.

Remember when Morgan Stanley bought land from Lennar (LEN) in December 2007 for a ‘pittance’? (And by the way, here’s how Lennar’s doing.)

Principle investments revenues were negative $1.8 billion. The majority of which relates to write downs in real estate limited partnership interests and other principle investments.

Non-interest expenses decreased 3% in the third quarter primarily driven by lower compensation expenses. This decrease is partially offset by higher costs related to credit which includes an impairment charge on real estate assets of $243 million. Approximately 90% of the credit portfolio is real estate assets primarily held at cost with quarterly depreciation.

Our total real estate net exposure which includes present as well as our direct investments in real estate, private equity and infrastructure costs was $5.3 billion at the end of the quarter. This exposure does not include assets included in investments for the measure of employee compensation or co-investment plans.

Hedge funds and money market redemptions put further stress on traditional Wall St. model:

Total assets under management decreased 30% to $399 billion largely due to the extreme drop in global financial mark during the quarter which had a broad impact towards the industry. We also recorded $77 billion in net outflows in the quarter, virtually all of them in our core business. The primary driver here was money market outflows of $51 billion due to the dislocation of the industry.

Nearly all these outflows occurred in September when credit and liquidity markets were under severe stress. During the quarter we repurchased approximately $25 billion of these securities to fund the investor redemptions amid the liquid markets. We reduced these positions substantially to $600 million at the end of November with no losses incurred. The current balance is roughly $200 million.

Q: [Money market outflows have] started to stabilize?

A: Yes.

We are not too encouraged about the overall state of the hedge fund industry.

Buyback’s, insider buying:

Q: Did you buy back any stock during the quarter?

A: Yes, I bought a small amount of stock back. Obviously this was pre-TARP and was a combination of two aspects of the stock. One we had some employee related buy backs which is the normal course of business and then in addition to that in those periods when our stock was trading down very low I bought back.

Deleveraging is over?

I don’t think leverage is going to go down any more. I think we have actually squeezed our balance sheet down actually preparing to take advantage of market dislocation. So I am hoping we can take leverage back up but to do that we need to see opportunities in the market and frankly I am still reeling from what happened in November.

Comments

[Abdul Kalam:]

What are you trying to justify with your article? Are you long or short MS?

2008 Dec 22 09:08 AM

[SA Editor J...:]

Dear Samrock001,

I'm not trying to justify anything, actually. The article provides what I think are key data points from Morgan Stanley's recent earnings call. Conference call excerpts is a service we provide at Seeking Alpha for investors so that they don't have to read through the entire conference call transcript to find out important trends or pieces of information that impact the stock or other stocks.
I hope you find it useful.
All the best,
Judy

2008 Dec 22 09:57 AM

[axelrod608:]

Personally I think MS is getting their just deserts. As a novice investor, the longer I had funds with MS the BROKER I got, though they made a ton on trades, fees, etc. Payback is sweet. I hope to serve them in a soup line someday.

2008 Dec 22 11:42 AM

[PeakOiler:]

Thanks for providing your summaries, Judy. This is a terrific educational website.

2008 Dec 22 01:17 PM

[spievak:]

I agree. Judy, I read your work every day. Thank you for your efforts and the quality of the research and writing!

2008 Dec 22 02:39 PM

[SA Editor J...:]

Thank you gents,
I appreciate the kind words.
Happy Holidays,
Judy

2008 Dec 22 05:10 PM