Morgan Stanley Is Still Massively Exposed To European Sovereigns

Morgan Stanley Times Square

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Morgan Stanley reported substantial holdings and counter-party exposure to European corporates, financials, and sovereigns when it announced fourth quarter results. The New York based firm, which recorded a loss of $0.14 per share, held more than $8.4 billion in gross risk to Italy, Spain, Greece, Ireland and Portugal at the close of the quarter.

Morgan held nearly $2 billion in hedges against those positions, protecting itself partially from losses if E.U. member’s or private companies based in the region were to default.

Gross exposure to Italy, which has been closely watched by analysts, surged 37% to $6.3 billion from the close of the third quarter in September. However, days after the close of the fourth quarter, Morgan aggressively cut its exposure to the country and its banks, as well as other peripheral nations, lowering total gross exposure to $5.0 billion.

“On December 22, 2011, the Company executed certain derivative restructuring amendments which settled on January 3, 2012,” the company said in a statement. “Upon settlement of the amendments, the exposure before hedges … for Italy decreased to $2,887 million.”

The restructuring came a day after the European Central Bank announced the results of its three-year long-term refinancing operation, which injected some €489 billion into Eurozone banks. 

In a research note this week, Huw Van Steenis of Morgan Stanley’s London operation, noted that Italian financials were likely the largest borrowers during recent ECB operations.

“Our research suggests Italian banks were the single largest users of the ECB LTRO funding – representing ~30% of the incremental €190 billion of liquidity injected and ~33% of the €489 billion. Spain followed with ~15% of the incremental liquidity and ~17% of the 3 year LTRO, we estimate.”

This specific funding operation, which included bids from 523 financial institutions, added tremendous liquidity to European markets and suggests that financials exited derivative transactions protecting themselves from near-term default by Italian banks. 

Elsewhere, Morgan remained exposed to a handful of peripheral nations that received downgrades by ratings agency Standard & Poor’s only last week.

In Spain, the bank had $1.7 billion gross exposure as of December 31, 2011, nearly all on private companies.

Portugal, Greece and Ireland accounted for a total of $433 million of Morgan’s exposure. Portuguese exposure was -$45 million during the period after short positions of $435 million reduced counterparty risk.

The bank was also short French single name positions by more than $1.7 billion, while extending $1.65 billion in funding lines to Franco corporates. Those lines include revolving credit facilities.

A spokesperson for Morgan Stanley declined to comment on the potential impact on first quarter revenue after these positions closed. However, she noted the move positively impacted revenue in the fourth quarter, as the company booked about $600 million on the release of credit valuation adjustments. 

Brad Hintz, an analyst at Sanford Bernstein & Co., saw the decline in exposure to peripheral banks as a positive development at Morgan. 

“The problem that you have with the derivatives book is that you have links to everybody. It takes a long time to get out of those links,” Hintz said on Bloomberg TV yesterday. “I think we should kind of tip our hat to Morgan Stanley. They pulled one off here in terms of reducing some of their potential exposure to some of the weaker European banks.”

Share in Morgan Stanley traded more than 5% higher yesterday. Below, a look at the bank’s exposure to selected Eurozone members.

Morgan Stanley Euro Exposure

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