Is Morgan Stanley's Biggest Asset Their Debt?

Tyler Durden's picture

Via Peter Tchir of TF Market Advisors

Stocks added to their rally today when Gasparino leaked news that MS was going to have a "solid" quarter and they were going to beat GS.

Morgan Stanley has $187 billion of public debt according to Bloomberg.  Just eyeballing it, the average maturity looks close to 4 years, but let's be conservative and assume it is 3 years.  I found a nice looking benchmark bond.  The MS 4.2% of 11/20/14.  It is a $2 billion issue.  The only round lot TRACE print on Sept 30th, was a dealer buy of $5 million or more at a price of 96.156.  That was a yield of 5.6%.  On June 30th, the bond TRACED a couple times at 103.6 to yield 3.08%.   A November 2014 treasury, yielded 0.47% on September 30th, giving a spread of 5.1%.  Back on June 30th that same treasury yielded 1% so the spread on this bond was just over 2% at the end of last quarter.

So MS 3 year bonds widened by over 300 bps during the quarter.  3 year MS CDS widened by 380 bps (from 113 to 493), so the move in bonds actually outperformed the move in CDS.  I do not understand exactly how banks account for spread widening in their P&L.  I don't think all of their bonds are in the "mark to market" book.  Maybe they can only write down the discount from par, rather than the full move, but these bonds alone, if they were mark to market, might generate 4% on $2 billion.  That would be $80 million.

Is MS planning on taking a massive gain on marking their own bonds?  There were stories of MS buying back their own bonds - a great move if they though they were cheap, but a critical move if they were planning on taking a gain and didn't want to have to give it back in the future if their credit spreads tightened.

Goldman has slightly less debt at $178 billion, but the spread widened far less. In the quarter GS 3 year CDS only widened by 224 bps (from 94 to 318).  I found a nice 3 year GS benchmark bond.  The 5.5% of 11/15/14 with an issue size of $1.3 billion.  On the 30th of Sept, 250k of these bonds traded at a price of 105.65 to yield 3.55%.  On July 1 and June 29th, these bonds traded at 108.6 on just over 250k to yield 2.8%.  It looks like the spread went from 180 bps to 308 bps.  Not great but a far cry from what we saw on MS.  The bonds were still above par, and with my limited knowledge of accounting, I would guess you cannot take a write down on bonds above par, unless you took a loss.

Is this why the MS CEO is so confident they will have a good quarter and beat GS?  I honestly hope not.  If the CEO of MS is playing accounting games (totally legal, but stupid) on their own spreads and thinks the markets will respect that, than I am very nervous about what is going on there.  The market is in turmoil, there are concerns out there, valid or not, and the CEO should not be worried about "beating the quarter" by taking accounting gains on their own debt.  Sadly, so far the facts fit.

The ability to book profits on your own debt widening makes sense in a very very limited way.  If you are running a match funded book with all your assets mark to market, then it makes sense to offset those losses against your funding.  Well, at least a little sense.  The problem is, that at the extreme, if you default you would have one amazing quarter when you got to right all your debt down, but it still means you are in default.  Actually I vaguely remember that in default you cannot book a profit on your debt widening, in fact you have to write it all back up to par.  One strange rule.

Again, I am just throwing this out there, but the facts fit as well as anything - Morgan Stanley has reduced risk, so how exactly are they going to blow the cover off the ball this quarter?  Volumes are down in most products, so it would be very impressive if they made it acting as agent.  In the end, I think they may be planning to take a big healthy gain on their own spread widening.  That fixes nothing, and I don't think many analysts will look through it, if that is their plan.

CDS spread performance of the TBTFs for Q3 - why MS beats GS?

and below stock performance for Q3...

Charts: Bloomberg

ZeroHedge Update: For those curious to learn more about this phenomenon, here is our first take on this paradox from April 2009!

ZeroHedge 4/22/09 - The Law Of Unintended "Fair Value Option" Consequences

Financial company stock prices have been on a tear these days, undoubtedly based on glowing, solid results. After all didn't Wells just have a blow out quarter? What is that you say, $5 billion in "earnings" were based on FAS 157-4 reversal and accounting gimmicks? Why should that matter to investors who are happy to buy N/M forward PE stocks any time Cramer top ticks the market, or the Power Lunch brigade glowers in the self proclaimed next American Golden Age.


Well, the financial ripfest, while benefiting bank prop desks (or at least the one that is left) may end up having some unfortunate side effects for none other than the banks themselves, and especially their accounting voodoo: the basis for the recently announced stellar financial results.


The issue at hand is the "Fair Value Option", which under US GAAP essentially allows the booking of a pre-tax profit when a bank's debt trades lower in the open market. This benefits banks that opt-in for FVO instead of other accounting approaches such as amortized cost, or historic cost.


And so readers can get a perspective of just how large an accounting "benefit" the FV Option is to financials, observe the table below which compares 2008 bank Net Income with the Pre-Tax Gain from Fair-Valuing of Own Debt.

For a somewhat rough proxy of how the five selected banks' debt securities have traded in recent times, please see the chart below.


Of the 2015 bonds, recent appreciation has been seen in Goldman Sachs and Credit Suisse bonds, while the remainder have remained relatively flat or have even declined. Of course, these are merely proxies and many more securities are calculated for FVO per GAAP.


Regardless, if the equity run up persists, its is inevitable that bond spreads will tighten (see this post for comparisons for credit and equity levels in financials), thereby eroding the FVO pre-tax accounting benefit for companies with appreciating securities, and in fact will result in a negative pre-tax treatment. How much of a negative contributor to EPS it is will ultimately depend on i) how high equity security prices go and ii) how much of a catch up role comparable credit securities play in their price. It is likely that the respective CFOs are too aware of this phenomenon, and could be one explanation for the divergence between equity values and bond prices. If bonds had experienced the same run up as stock prices, the recently announced EPS for the major banks would have been much more adversely impacted.

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Henry Chinaski's picture

They should put the money they don't have into STRIPS.

max2205's picture

This explains exactly why US accounting rules are FOR SHIT.


slewie the pi-rat's picture

the lipstick the accountants are putting on the 3rd quarter pig will set new fashion & beauty standards!

Ahmeexnal's picture

CME issues another margin hike today: 15% on copper.

Expect Ag and Au margin hikes tomorrow or friday.

CompassionateFascist's picture

Here's an item which arrived in today's mail that may offer a more direct insight into the state of the TBTFs. The local branch of one such is offering $150 up front for a 90-day deposit of $10,000, $500 for a 90-day of $20,000. Still hoping that this train won't go over the cliff until summer 2012, but I don't know....

Cynical Sidney's picture

i too received a stack of those in the mail.

call your congressman email your senators to urge them to look into FAS159 'fair valuing option' of debt obligation

as their constituents it's your prerogative, your duty to press them into action

this cannot be tolerated book value on equities then fair value on liabilities

tb2f translates to 2big2be saved, 2unhanded2fall, 2corrupted2fail

these banks are leveraged to the extent that even if they rob us clean suck us dry

as they have been doing in the past, the 2b2f banks would as as soon all go down in flames

due to their over-exposure in overseas markets. bring it to the attention of your congressman

electoral support henge on the course of action taken by your respective representatives.

The Big Ching-aso's picture

Especially if they shave its legs and have it wear pumps.

Bendromeda Strain's picture

Does this debt make my asset look big?

Foxinsox's picture

Not just US, these rules are almost identical under IFRS!

oogs66's picture

it is 2008 again!  cramer was wrong

X.inf.capt's picture

more like the1930's...if were lucky...

Comay Mierda's picture

More like 1776, revolt against the interest bearing currencies peddled by the banking cartel of england, return sovereignty to countries around the world

Ahmeexnal's picture

More like 476, when the german barbarian Odoacer betrayed Romulus Augustus and the Roman empire was officially done for.


mossme89's picture

More like the beginning of the millenium when the Internet bubble popped and we were all about to die because of computers. Only this time, the computers own the market. OMG!

Freddie's picture

SkyNet and the algos run the show now.

Comay Mierda's picture

Difference this time around is that our fearless leaders will engineer major false flag attacks or start nuclear war to distract the sheeple from their wealth consolidation

Bartanist's picture

Right now, it looks as if the group "Anonymous" is untouchable by the Feds, CIA, NSA etc. They can hack anything and get away with it. How is this possible? It only seems to make sense to me if "Anonymous" is a US government operation (or maybe run offshore through a cooperative government).

Why would they do this?

Look what is happening outside of Wall Street in the park.

My guess is that the end of this story is already written.

- Anonymous, the hackers built up in the media to be untouchable, crash Wall Street.

- The OWS protestors are portrayed as winning and everyone wanting to see those evil Wall Street types punished feels good and yet poorer

- The fraud is unrecoverable and buried under data rubble comparable to the way the $2.3 trillion was buried in the Pentagon attack and the ENRON fraud data was buried and quickly carted away from the building 7 destruction.

- Someone will once again steal a boatload (of gold or whatever) as part of the operation

- And we will find Silverstein-like complicit parasites benefitting from the destruction.

It is the only way I can tie the three seemingly unrelated pieces together that makes sense.

topcallingtroll's picture

I am thinking more like 76 CE or AD if u prefer

faustian bargain's picture

How about that time when Cain killed Abel because he was God's favorite...

The Fonz...before shark jump's picture

But bonus season is coming up...

Smithovsky's picture

Maybe some of this profit comes from their mark-to-fantasy book

Alea Iactaest's picture

Maybe some of it comes from writing puts the whole way down knowing they will expire worthless.

Smithovsky's picture

Or writing OTM calls on themselves, knowing those'll expire worthless as well.  

wombats's picture

Maybe they can swap them for BofA bonds.

G_T_A_44's picture

2008 was merely the appetizer. What's forthcoming (and presently in the works/early innings) will make '08 look like childs'play.


Furthermore, they're all Barbi-Qng the books!

Manthong's picture

" I do not understand exactly how banks account for spread widening in their P&L."

  I do.

pragmatic hobo's picture

didn't lehman do this?

Belarus's picture

The large PD's and banks are all virtually bankrupt. It's just about pretending until one day their earnings outrun their balance sheet losses...

It's how it's done in America. Only problem is: there is and will be no growth. I heard Jamie Dimon talking about how everyone is underestimating the consumer because the are saving 5% and that their incomes are going up. So if they keep spending the same 95% and their incomes are going up well then, according to the Chief of Ponzi JPM, that will be amazing for the economy.

But wrong, and wrong Jamie. The problem is the 1 trillion in Disposable Income Growth since 2007, which gives way to the personal consumption line, has been solely benn attributed, or at least 80% of it, to two things: lower taxes and transfer payments for the United States Treasury. Lower taxes from borrowed money and transfer payments from borrowed money. 

With GDP at 2%, at best and only if you've got your rose colored glasses on anyway, there is no way to get real growth, not statiscal B.S. like measuring GDP in a vacuum. but no kidding real growth. And so what happens when you take away the punchbowl: the lower tax base and/or the transfer payments to try to plug the unfunded hole? 

Yup, Jamie Satan Dimon, anyone listening to you is going to get flogged and fleeced. Back to MS, they are basically fucked but no one will ever let them be...."here we come taxpayers, yet again" should be the TBTF's slogan.

Belarus's picture

One other point, you just know Buffett buying the preferred on BAC is a bad omen for the tax payer. This is cut and paste script for him from the 08 crises. He knows BAC is TBTF, and since management has been somewhat replaced, you just know they will be recapitalized when they are virturally down under.....leaving, of course, Buffett's preferred nice and peachy. 

And this should be considered inside information, because we know Obama will call Buffett to ask him what they should do when BAC ultimately bites the bullet. 


Joshua Falken's picture

Morgan Stanley are using cheap money to levereage their delta one, algorithmic and high frequency trading desks.  All the "hot shot" proprietary traders have gone to be replaced by floors of sales/traders constructing every possible iteration of linked and packaged structured product baskets and ETF's to be sold globally to private bankers and financial advisers.  

The initial selling margin is good, but the real edge comes in trading and manipulating the underlying basket to their own advantage.  Just look at how Morgan Stanley's VAR has balloned in the last few years as these programs require vast resources, but little unhedged outright underlying exposure (unless you have a Kerviel or Adoboli in your midst). Talk at the water cooler is that the delta one, algorithmic and high frequency trading desks are making out like bandits.

This is all very clever and makes loads of money at other peoples expense and certainly doesn't treat customers fairly.  

The unravelling comes when counterparties, credit, currencies or interest rates give birth to a black swan and Morgan Stanley's funding tightens.

Everyone thought Drexel Burnham, Bear Sterns and Lehman would be alright until they were not.

If you want to see the future - look at  and

buzzsaw99's picture

This is dorked up. Their bonds are crashing so they book this as a gain, however if they buy the bonds at less than par on the open market then they are in default? Corporate accounting ubersux. Somehow I know this is going to translate into more bonuses. Pass the booze.

rocker's picture

Most believe that the market will mimick 2008's decline, and it may.

I am just thinking about all the bullish talk from the pumpers and risk on crowd pounding the table.

I have never heard Bloomberg so bullish everyday. Every rally is explained as investors buying stocks.

Never explained as a Short Covering Rally.  Surely Robo is buying PCLN, CMA, and AMZN.  This has just got to be bullish.

Right ?    LOL    Not with my money.   I have to see real capitulation.  I have not.

Keeping Capital is more important than growing it at this point.  Including my Physical PMs.

buzzsaw99's picture

I'll take "what is the opposite of a kitchen sink quarter" for $200 Alex. This smacks of bonus conjuring to me ala JPM booking loan loss reserves as profit. Call it the "desperation scraping the bottom of the scuz bucket turning shit into champagne quarter" if they do this.

Bendromeda Strain's picture

The Cold Duck Quarter! Enough cold ducks and a black swan is not required.

Prometheus418's picture

It won't mimic 2008.  The period between crashes was too short, and most people never recovered- when it goes again, it's going to turn millions off from any kind of investment at all, probably for good.  The fact that shorts keep getting slammed by last-second algo driven rallies isn't helping, either- retail investors might be willing to adjust and learn new strategies, but not when every attempt leads to losses.

Bankers and hedge funds will trade amongst themselves for a while, I'm sure- but eventually, it's not going to be much fun for them, either, as the money is just shuffled back and forth, with no one left to fleece.  

I expect that from here on out, there will be a few generations that won't put a nickel in a bank, and keep thier savings in coffee cans and under matresses.

unununium's picture

buzz, I don't know where you get that buying for < par is a default event.

Rather, Tschir thinks maybe these fantasy earnings disappear IF company is in default.

Nobody has mentioned the most infuriating thing, which is that FASB lets these assholes mark everything else to fantasy, but mark this one item to market since it is the one thing that results in a benefit.

All semblance of fair accounting has disappeared.  God save us.

Schmuck Raker's picture

Where have I heard of this type of stunt before?

Maybe it's the rum talkin', but I could swear that back in '07-'09 this sort of story was floating around about somebody.

Any of the Gurus-That-Be remember ish?

buzzsaw99's picture

enron, and more recently merrill were both fond of buy-back shenanigans.

Schmuck Raker's picture

Thanks Pete, Tyler, and Buzz.

I should have never doubted the rum.

faustian bargain's picture

I bet there's some stuff in the Zerohedge archives if you search for Repo-105.

The4thStooge's picture

So basically they've got a bunch of bad dynamite laying around that could go off at anytime, and to keep themselves from blowing up, they're gonna buy back some of the dynamite they've sold to other firms. Sounds like something a suicidal financial terrorist would do.

Sequitur's picture

Great post. This is the only thing these goddamn banks and their client "technology" is good for: massaging the books and bullshitting the market. Hire some vapid accountants and lawyers to pass on this FASB accounting a la Enron, Worldcom, Quest.

chump666's picture

MS is pile of crap.

Watching Asia's thin volume melt-up.  Tasty.

Lets see, three days of meltups, thin volumes (asia) somewhat tightening on Asian CDS's, European 'leaders' are now clinically insane, US markets rallying on panic buy-ups...

Next week will be a bloodbath.




Big Ben's picture

Could the MS executives be pulling out all accounting stops hoping to print one last good quarter before everything falls to pieces?

It could be that bonuses are computed based on earnings, regardless of whether or not those earnings come from accounting gimmicks.

The MS equation: (shareholder_equity) + (taxpayer_bailouts) = executive_bonuses

Sambo's picture

The CEO told the other MS employees not to expect big bonuses this year.

If they are going to have a great qtr, why hold back the bonuses?