MUFG gets Morgan Stanley to agree to sweeter terms

The Japanese bank insists on all preferred stock and a lower conversion price than earlier agreed, but the capital injection goes through, prompting an 85% rally in Morgan Stanley's share price.
JapanÆs largest financial group, Mitsubishi UFJ Financial Group, met the deadline for its $9 billion bailout investment in Morgan Stanley, but significantly revised the terms to reflect the drop in the US investment bank's share price and the changed market conditions.

MUFGÆs entire investment, which will give it a 21% stake in Morgan Stanley, will now be in the form of preferred stock. It will buy approximately $7.8 billion of perpetual, non-cumulative, convertible preferred stock, which is convertible at a price of $25.25 per share, and $1.2 billion of perpetual, non-cumulative, non-convertible preferred stock. Both the convertible and non-convertible preferred stock will carry a 10% annual dividend.

Half of the convertible preferred stock automatically converts into equity after one year, subject to Morgan StanleyÆs stock trading above 150% of the conversion price for a period of at least 20 trading days out of 30. This means Morgan Stanley has to trade above $37.875 for the said 20 days. The other half of the convertible preferred stock will convert on the same terms after two years.

The non-convertible preferred stock is callable by the issuer after three years at 110% of its face value.

MUFG has also insisted on clauses to protect its equity stake from being diluted through any sort of issuance to the US government as part of a bailout package, say sources.

Morgan StanleyÆs shares closed at $9.86 on Friday, October 10, up from a 52-week low of $6.71 touched earlier in the same session. It was widely anticipated that the deal between the parties would have to be renegotiated because Morgan Stanley was trading around $23 when the original agreement was forged at the end of September.

The earlier agreement had envisaged the Japanese firm investing $9 billion in a combination of preferred stock ($6 billion) and straight equity ($3 billion). The straight equity was being issued at $25.25 per share and the preferred stock was convertible at $31.25 per share.

MUFG and Morgan Stanley have indicated that they intend to work together in the areas of corporate and investment banking, retail banking, asset management, as well as lending activities such as corporate and project-related loans. The two firms also intend to establish a steering committee and indicated that they aim to complete definitive documentation with respect to the alliance by June 30, 2009.

MUFG will have the right to appoint one director to the board of Morgan Stanley as long as it owns more than 10% of the US investment bank.

Morgan Stanley reiterated that with the MUFG infusion, its tier-1 capital ratio would have been 15.5% as of August 31, 2008, and its leverage ratio has been reduced to just under 20 times.

MUFG was advised by Lazard, with Sullivan & Cromwell and Mori Hamada & Matsumoto providing legal advice. BlackRock advised on asset valuation.

Morgan Stanley took legal advice from Wachtell, Lipton, Rosen & Katz.

MUFGÆs shares rose 15.5% to $7.68 in New York trading Monday and Morgan Stanley rallied 85% to $17.92. The shot in the arm, or in this case balance sheet, by MUFG seems to have been just the fillip shareholders needed.

Meanwhile, the $5 billion infusion Morgan Stanley got from China Investment Corp in December 2007 will convert in 2010 at a price between $57.68 and $69.22 per share. With hindsight, Morgan Stanley would have done well to invite CIC to take more than a 9.9% stake, or bring in further investors on similar terms.

But others comment that no-one could have predicted how quickly the market meltdown would unfold once Lehman Brothers filed for bankruptcy and how much ground the share price would lose. Indeed, markets have been in freefall with the result that even cash-rich investors like the sovereign wealth funds in the Middle East have been noticeably absent from negotiating tables.

The Japanese firms that are coming to the rescue this time around are, unlike the earlier bailout investors, bringing more than just financial capital to the table. They intend to be involved in strategic decision-making. But if there is one thing the subprime crisis has proven yet again, it is that financial markets may be a high-reward business, but one that comes with equally high risk. Japanese firms will need to put in place strategies, checks and balances to ensure their capital is protected as well as yielding returns.

The world has had to relearn these lessons at high cost and with immense pain over the past few weeks.
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