Morgan Stanley, MUFG renegotiating pact

Japan's Mitsubishi UFJ Financial Group <8306.T> , which watched Morgan Stanley's <MS.N> share price plunge 58 percent last week, is amending its $9 billion deal to include only convertible preferred shares and no common stock, a person familiar with the matter said.
Morgan Stanley is the latest stricken U.S. financial institution to seek refuge in a deal with a larger bank as the worsening credit crisis and accompanying market meltdown has narrowed the options of once stable banks and brokerages.
The Morgan Stanley news comes as Spain's Banco Santander SA <SAN.MC> was in advanced talks to buy full control of Sovereign Bancorp Inc <SOV.N> in a deal valued at $2.5 billion, according to a source familiar with the matter. [ID:nN12402426]
Under the revised terms of the MUFG deal, Morgan Stanley will still sell a 21-percent stake to MUFG for $9 billion, but the amount will be entirely in convertible preferred shares, the source said. The original terms included $6 billion in convertibles and $3 billion in common equity.
Exact details have not been disclosed, but the new terms will allow MUFG, Japan's largest bank, to buy preferred shares that will convert into common stock at a price range of $20 to $25, the source said. This was down from an initially negotiated price of $31.25.
MUFG's move to seek convertible shares instead of all stock avoids a near-term loss, while still letting it benefit when the shares recover.
In the meantime, MUFG will also earn high-yielding 10 percent interest on the preferred shares.
As part of the MUFG deal, the company will also provide letters of credit and a credit line to support Morgan Stanley in a move that would reassure investors worried about the U.S. bank's liquidity.
The U.S. government will not invest alongside MUFG, the source said.
The Wall Street Journal earlier reported that the government would express its support for the deal and work to structure any potential future investment in Morgan Stanley in a way that wouldn't wipe out MUFG's investment.
MUFG has been under some pressure to change terms of the deal because its original investment for 21 percent of the firm was agreed to before Morgan Stanley lost more than half its value last week, reducing its market value to $10.3 billion.
The investment bank, founded in 1935 by former executives of JPMorgan Chase & Co <JPM.N>, was long one of Wall Street's pillars of strength, second among independent investment banks only to Goldman Sachs <GS.N>.
But the iconic bank is battling a crisis of confidence and some suggest that it could be a test case for the U.S. government's new strategy of deploying its $700 billion bailout fund by buying equity stakes in banks.
"Morgan Stanley urgently needs rescue. The Treasury should offer to match Mitsubishi's investment with preferred shares whose conversion price is higher than Mitsubishi's purchase price," investor George Soros wrote in an editorial published in the Financial Times newspaper.
"This will save the Mitsubishi deal and buy time for successfully implementing the recapitalization and mortgage reform programs."
Morgan Stanley, which closed down 22.3 percent at $9.68 Friday on the New York Stock Exchange, declined comment.
DEAL WAS EXPECTED TO CLOSE TUESDAY
The company had said that come this Tuesday, its agreement to sell a 21 percent stake to MUFG for $9 billion could be completed. Yet many investors were convinced that Morgan would not make it that long, hammering the stock price to its lowest in 14 years.
Morgan Stanley's decision to get an infusion of capital comes at a time when U.S. banks have been hit hard by the credit crisis and are looking for ways to survive.
In a related development, European leaders raced against the clock on Sunday to craft a rescue strategy for banks hit by the worst financial crisis since the 1930s, focusing on pledges to recapitalize banks or buy debt they issue.
Insiders at Morgan Stanley are confident that once a deal closed, the Mitsubishi partnership would give the company access to deep pockets that would reassure investors and clients.
That Morgan Stanley finds itself on the precipice has left many employees at the fifth-largest U.S. bank frustrated. Under John Mack, who took over as chief executive in June 2005, Morgan Stanley took on more trading risk and expanded in lending and mortgage businesses that have proven to be the biggest money losers of the credit crunch.
Yet since the bank wrote down more than $9 billion of assets last December, Morgan Stanley shifted to defense. It shed assets, reduced leverage and raised $5 billion of capital from China Investment Corp — a move that made it look smart as Bear Stearns Cos Inc and Lehman Brothers crumbled for lack of willing investors.
These moves were not enough to stop the relentless decline in the stock. So a week after Lehman collapsed, and as U.S. authorities bailed out American International Group Inc <AIG.N>, Morgan Stanley engaged in merger talks with Wachovia Corp <WB.N> — a large but weakened commercial bank — and then converted itself to a commercial bank. Morgan dropped the Wachovia talks as it unveiled a preliminary deal to sell a 20 percent stake to MUFG.
That deal, which would bring in reassuring capital, was wrapped up rapidly; yet it might not have been fast enough. In the five-day waiting period imposed by antitrust regulators, Morgan Stanley's stock price continued to plunge. Ratings agency Moody's turned up the heat by warning that Morgan's rating could get cut.