Morgan Stanley Answers Shorts with Europe Disclosure (Update 1)

Morgan Stanley article updated with management and analyst commentary.

NEW YORK ( TheStreet) - Shares of Morgan Stanley ( MS) were rising Wednesday after the investment bank offered more details on its exposure to Europe, arguing that its actual risk from the European crisis is much less than previously reported.

The investment bank said its total exposure to the peripherals- Greece, Italy, Ireland, Portugal and Spain- as of September 30 stood at $5.68 billion. Net funded exposure after hedges on net counterparty exposure and lending was approximately $2.1 billion. That was in line with numbers disclosed last quarter.

The latest disclosure, however, breaks out its exposure to each of the countries, offering further details on its inventory, counterparty exposure, funded lending and purchase of credit protection. The investment bank has the most exposure to Italy at $4.5 billion. Net of hedges on counterparty exposure and lending amounting to $2.78 billion, its exposure to Italy stood at $1.79 billion or 85% of its peripheral exposure.

In addition to the gross funded exposure, Morgan Stanley had European peripheral country exposure for overnight deposits with banks of approximately $386 million and unfunded loans to corporations of approximately $904 million.

The investment bank also revealed more details of its exposure to France, which has been the subject of a lot of speculation lately. The company said its total exposure after adding its net inventory positions, net counterparty exposure, funded lending and CDS adjustments stood at $1.53 billion. Its exposure after hedges was actually a negative $286 million.

Analyst Matt Burnell at Wells Fargo and Sanford Bernstein analyst Brad Hintz estimated Morgan Stanley's exposure to France and its banks to be less than $2 billion, net of collateral and hedges.

Morgan Stanley said in a filing with the Securities and Exchange Commission last year that its exposure to France was $39 billion, significantly higher than its market capitalization. But analysts have pointed out that the numbers in that report were "gross" figures that exaggerated its exposure, because it failed to take into account collateral and included all funds including client funds held in French bank accounts.

During the analyst conference call Wednesday, CFO Ruth Porat also said that the filings with regulators revealed "notional" amounts and were not a real measure of risk.

Morgan Stanley has been battling rumors ranging from its exposure to French banks, that are vulnerable to a collapse in Greece, to its derivative exposure, as the debt crisis in Europe triggered fears that the investment bank will end up dealing with a funding crisis similar to what it experienced in 2008.

The cost of buying 5-year credit default swaps (CDS), which offer protection against the investment bank's default, surged from 161 basis points at the end of the second quarter to 490 basis points by the end of September 30. In the first week of October, it climbed past 600 basis points - wider than the spreads on even some of the French banks that the market fears it is exposed to- before cooling off to below 430 basis points in recent sessions.

Shares of Morgan Stanley have shed more than 20% in the last three months.

Morgan Stanley CEO James Gorman last month attempted to quell the rumors in a memo to employees. "In fragile markets, where fear triumphs over common sense, these things are bound to happen," the CEO said in an internal memo. "It is easy to try to respond to the rumor of the day, but that is not usually productive."

The latest disclosure might help calm some of these fears. "Morgan Stanley is clearly increasing its disclosure to reassure creditors and counterparties," Sanford Bernstein analyst Brad Hintz told TheStreet in an email. "Essentially the company is trying to end speculation among players in the CDS market by disclosing everything that worried the market."

Hintz pointed out that the investment bank bought back debt during the quarter. "This is a very important disclosure to banks, risk managers at other firms and fixed income market participants because this disclosure is prima fascia evidence that the company was NOT facing a funding run in August."

The analyst reasoned that Morgan Stanley will not attempt to buy back its debt if its management felt it could not fund the firm.

Banks have actually been able to benefit from the widening spreads because of an accounting quirk that allows them to book a profit from the falling value of its own debt. Morgan Stanley beat estimates for the third quarter by a wide margin, but the gains came principally from its higher-than-anticipated debt valuation adjustment or DVA gain of $3.4 billion.

Other banks including JPMorgan Chase ( JPM), Bank of America ( BAC) and Citigroup ( symbol) have reported gains close to $2 billion. as Goldman Sachs ( GS) saw smaller gains because it hedges against moves on its credit spreads.

But wider spreads could potentially pose funding problems for investment banks such as Goldman and Morgan that are more dependent on wholesale funding.

The higher perception of risk could also increase their collateral requirements and affect client relationships.

Goldman Sachs said on Tuesday that they were unaffected by the higher CDS spreads.

Porat said during the conference call that the widening credit spreads had been frustrating but that they had had productive conversations with clients on the many changes that had been made to their business model since the beginning of the crisis.

"We have seen some moderating of spreads and hopefully the incremental information should have some effect," Porat said.

Shares of Morgan Stanley were rising 2.5% to $17.01 in morning trading.

--Written by Shanthi Bharatwaj in New York

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Disclosure: TheStreet's editorial policy prohibits staff editors and reporters from holding positions in any individual stocks.

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