Morgan Stanley's Subprime Assets Fell by $3.7 Billion (Update1)

By Christine Harper


Nov. 7 (Bloomberg) -- Morgan Stanley, the second-biggest U.S. securities firm, said its subprime mortgages and related securities lost $3.7 billion in the past two months, after prices sank further than the firm's traders expected.

The decline may cut fourth-quarter earnings by $2.5 billion, the New York-based company said in a statement today. The figure is subject to change until the end of this month, Morgan Stanley said. The average estimate of analysts surveyed by Bloomberg is for a $1.93 billion profit in the quarter.

Competitors including Merrill Lynch & Co., the third-largest securities firm, and Citigroup Inc., the biggest U.S. bank, have also reduced the value of their mortgages and bonds backed by the loans. The companies are getting stuck with losses after a surge in U.S. mortgage defaults this year prompted investors to shun the securities as well as other high-risk, high-yield debt.

``The dislocation in the market has been quite severe, liquidity has dried up,'' said Colm Kelleher, Morgan Stanley's chief financial officer, in an interview. ``You need to see some of these long positions reduced, you need to see buyers coming in, you need to see an easing of liquidity in the market.''

Kelleher said he now estimates the credit markets will take three or four quarters to recover, instead of the one or two he estimated when the firm reported third-quarter results on Sept. 19.

`Proprietary Position'

Part of the losses stemmed from derivative contracts the firm's proprietary trading unit wrote earlier in the year, Kelleher said. The traders anticipated a decline in the value of subprime securities, and the contracts made money for the firm in the second quarter, he said. They started losing money when prices fell below the level the traders had anticipated, Kelleher said.

``These exposures did not come out of our client-facing activities, these were a proprietary position we put on,'' Kelleher said in a conference call with analysts today. ``As markets continued to decline our risk exposure swung from short, to flat to long.''

The people responsible for the losses no longer work at the firm, said Morgan Stanley spokeswoman Jeanmarie McFadden. She declined to name them.

Concerns about potential writedowns at Morgan Stanley have pushed the stock lower this week, bringing the year-to-date decline to 24 percent. The stock fell $3.32, or 6.9 percent, to $51.19 in New York Stock Exchange composite trading today.

David Trone, an analyst at Fox-Pitt Kelton Cochran Caronia Waller, yesterday cut his recommendation on Morgan Stanley to ``in line'' from ``outperform,'' saying he expected the company to write down as much as $6 billion in securities.

He estimated the firm would lose about $4 billion on asset- backed securities and collateralized debt obligations and expected the remaining losses to be booked on residual mortgage interest and on credit lines to structured investment vehicles.