NEW YORK—China has agreed to pump $5 billion into Morgan Stanley as the U.S. investment bank reported a stunning fourth-quarter loss fueled by $9.4 billion of losses in subprime mortgages and other assets.
China's investment, which could translate into as much as a 9.9 percent stake in Morgan Stanley, marks the latest capital infusion by a sovereign wealth fund into a major investment bank hurt by this year's credit crunch.
Morgan Stanley shares rose more than 4 percent as investors hoped the large write-downs and cash injection by China's foreign exchange fund may be signs of the beginning of the end of the subprime mess. But some skeptics said the deal was a sign of weakness.
"This is a painful deal," Sanford Bernstein analyst Brad Hintz said in a research note. "When you leverage a brokerage firm up 31 times and you take a loss, you don't have any choice but to negotiate a nice deal to bring in equity capital."
Unlike his colleagues at Merrill Lynch and Citigroup, Morgan Stanley Chief Executive John Mack did not step down, but said he would forego his bonus this year. Mack, who pocketed $37 million in salary, bonus, restricted stock and other compensation last year, last month ousted protege and co-President Zoe Cruz and shook up the firm's fixed income and risk management leadership.
"The results we announced today are embarrassing for me," Mack said in a conference call of the investment bank's first quarterly loss in its 72-year history.
Last month, Morgan Stanley said traders betting the bank's own capital had incurred $3.7 billion in losses on U.S. subprime mortgages. Wednesday, the bank disclosed another $5.7 billion in write-downs, reflecting further declines in the mortgage trades and losses on other debt.
To restore its capital, Morgan agreed to sell equity units that pay a 9 percent coupon. China will be a passive investor.
The deal reinforces Morgan Stanley's ties to China's vast, rapidly growing markets. More than a decade ago, Mack, then its president, helped forge the China International Capital Corp banking venture in which Morgan owns a passive 34 percent stake.
Earlier this month, Mack traveled to China to forge a new investment banking venture with Shanghai-based China Fortune Securities. The bank is pursuing licenses that will let it undertake banking and money management operations there.
Morgan Stanley is the latest big bank bailed out by sovereign funds recently.
Citigroup Inc agreed last month to sell a 4.9 percent stake to Abu Dhabi for $7.5 billion, while UBS accepted a $9.75 billion investment from Singapore's investment arm.
With the write-downs knocking down earnings by $5.80 a share, Morgan Stanley posted a net loss from continuing operations of $3.59 billion, or $3.61 a share, in the quarter ended Nov. 30.
A year earlier, Morgan had income from continuing operations of $1.98 billion, or $1.87 a share. Morgan's results reflect the spin-off of Discover Financial Services in July.
Analysts expected Morgan Stanley to lose 39 cents a share.
Morgan Stanley's results come a day after Goldman Sachs Group Inc reported a 2 percent profit increase as its fixed income traders sidestepped the credit problems that snagged the rest of Wall Street. Lehman Brothers Holding Inc said last week that earnings fell 12 percent after $3.5 billion in write-downs.
Morgan said $7.8 billion in write-downs came from subprime trading positions that fell further after the bank's Nov. 7 warning. Morgan also wrote down $1.6 billion of mortgages held by a bank unit, commercial mortgages and other loans.
It is a sizable loss compared with Citigroup, which last month warned it could write off assets worth $8 billion to $11 billion. Merrill Lynch & Co Inc wrote off $8.4 billion in the third quarter, with more losses expected.
Morgan said it reduced its exposure to problem assets during the quarter. U.S. subprime mortgage were pared down to $1.8 billion Nov. 30 from $10.4 billion in August.
"The fact that there's only $1.8 billion left in subprime exposure suggests they are getting to the end," said Steve Goldman, market strategist at Weeden & Co in Greenwich, Connecticut.
The trading debacle was the first serious setback for Mack since he replaced Philip Purcell as CEO in 2005. Mack directed the bank to take on more risk and expand businesses such as mortgages and leveraged lending to boost profit and growth.
Earlier this year, those efforts were paying off as Morgan reported mortgage gains, even as subprime markets started to falter. But Morgan's proprietary bet against mortgages backfired as the market worsened beyond what traders expected.
Morgan Stanley's institutional securities unit posted a pretax loss of $6.5 billion, compared with $2.2 billion of pretax income last year.
Executives at Morgan Stanley said the losses overshadowed strong results from the rest of the company, including record annual revenue in many businesses and rising profit from overseas markets. Within fixed income, foreign exchange and interest rate trading, results were strong.
"This loss was the result of an error in judgment that occurred at one (trading) desk ... and a failure to manage that risk appropriately," Mack said.
Morgan Stanley shares closed up $2.01 at $50.08 on the New York Stock Exchange, even as Morgan Stanley executives offered a sobering outlook and warned that its credit and mortgage business would slow.
Chief Financial Officer Colm Kelleher told Reuters the bank would suspend buybacks as it reviews its capital levels and investment plans. Mergers and leveraged buyout activity also is expected to slow.
"The near-term outlook is challenging," Mack said. "The mortgage business is going to be dramatically reduced. Credit and leveraged lending will be on a lower basis as well."
The slowdown in some businesses means Morgan Stanley, which announced 900 layoffs in recent weeks, may cut more jobs and shift resources to other, faster-growing areas, Kelleher said.