Morgan Stanley's Albatross: Real Estate

By AARON LUCCHETTI and ANTON TROIANOVSKI

In Atlantic City, N.J., construction on a 47-story casino project financed by Morgan Stanley is moving along despite the gambling industry's slump. The bad news: The 1,900-room hotel and other glitzy amenities won't be finished until the developer can raise $700 million.

Morgan Stanley's exposure to commercial real estate is one of the reasons why analysts expect the New York company to report on Wednesday a net loss of $555 million, according to Thomson Reuters. That would be the firm's third quarterly loss in a row, even as rival Goldman Sachs Group Inc. revels in the record profit it reported last week.

Morgan Stanley has been pinched by bad real-estate bets, like the partially completed Revel Casino in Atlantic City, N.J., shown here in January. Much of Morgan Stanley's red ink will come from an adjustment to borrowing costs and paying back the Troubled Asset Relief Program. But bulking up on commercial real estate when times were good also is taking a bite out of the bottom line now. Morgan Stanley, before hedges, had about $18 billion in such exposure in its institutional securities unit as of March 31, less than many large commercial banks but double the size of Goldman's bets.

Commercial real estate is "still a cloud over" Morgan Stanley, says Brad Hintz, an analyst at Sanford C. Bernstein & Co., who expects "modest" write-downs that could dog the firm until the economy rebounds. Credit Suisse analyst Howard Chen says he expects as much as $300 million in write-downs at Morgan Stanley's institutional unit from commercial real estate.

In the federal government's stress tests, Morgan Stanley faced potential losses of 45% on its commercial real-estate loans under the worst-case economic scenario, the steepest percentage of any financial institution that underwent the tests. In the institutional unit, Morgan Stanley already has sharply lowered the carrying value of its commercial loans and securities to about 50 cents on the dollar, and hedges have helped the firm generate gains on its holdings in recent quarters. The company has said its net exposure, or potential losses if defaults occur, was $4 billion in the first quarter.

Meanwhile, much of the $1.5 billion in losses in Morgan Stanley's asset-management unit in past year came from commercial real-estate investments.

Morgan Stanley is essentially the sole backer of the Atlantic City casino project, where construction by closely held developer Revel Entertainment LLC began in 2007. Morgan Stanley wanted to bet on casinos, but its exposure deepened when Revel wasn't able to line up financing.

Morgan Stanley's investment could total at least hundreds of millions of dollars, though the project isn't expected to significantly affect this quarter's earnings. The casino might open in mid-2011 if Revel can get financing by year's end, says Joel Simkins, a Macquarie Capital analyst.

Morgan Stanley has more than $2 billion in exposure to its Crescent real-estate portfolio of office buildings, resorts and other properties, while taking steep write-downs in MSREF VI International, an $8.8 billion commercial real-estate fund.

Separately, Morgan Stanley said Monday that it hired hedge-fund manager Jack DiMaio, 42 years old, to run a big part of its bond- and currency-trading operations. The move reflects Morgan Stanley Chairman and Chief Executive John Mack's dissatisfaction with the bond-trading unit's recent results. Roberto Hoornweg, now the firm's head of interest rates, currency and credit, is leaving Morgan Stanley, a person familiar with the matter said. Mr. Hoornweg declined to comment.

After Mr. Mack became CEO of Credit Suisse First Boston in 2001, he renegotiated downward contracts that previously guaranteed Mr. DiMaio and his bond-trading team roughly $300 million when the group threatened to defect to a Barclays PLC unit.