The night before the Archegos Capital story burst into public view late last month, the fund's biggest prime broker quietly unloaded some of its risky positions to hedge funds, people with knowledge of the trades told CNBC.
Morgan Stanley sold about $5 billion in shares from Archegos' doomed bets on U.S. media and Chinese tech names to a small group of hedge funds late Thursday, March 25, according to the people, who requested anonymity to speak frankly about the transaction.
It's a previously unreported detail that shows the extraordinary steps some banks took to protect themselves from incurring losses from a client's meltdown. The moves benefited Morgan Stanley, the world's biggest equities trading shop, and its shareholders. While the bank escaped from the episode without material losses, other firms were less fortunate. Credit Suisse said Tuesday that it took a $4.7 billion hit after unwinding losing Archegos positions; the firm also cut its dividend and halted share buybacks.
Morgan Stanley had the consent of Archegos, run by former Tiger Management analyst Bill Hwang, to shop around its stock late Thursday, these people said. The bank offered the shares at a discount, telling the hedge funds that they were part of a margin call that could prevent the collapse of an unnamed client.
Signage is displayed outside Morgan Stanley & Co. headquarters in the Times Square neighborhood of New York.
Michael Nagle | Bloomberg | Getty Images
But the investment bank had information it didn't share with the stock buyers: The basket of shares it was selling, comprised of eight or so names including Baidu and Tencent Music, was merely the opening salvo of an unprecedented wave of tens of billions of dollars in sales by Morgan Stanley and other investment banks starting the very next day.
Some of the clients felt betrayed by Morgan Stanley because they didn't receive that crucial context, according to one of the people familiar with the trades. The hedge funds learned later in press reports that Hwang and his prime brokers convened Thursday night to attempt an orderly unwind of his positions, a difficult task considering the risk that word would get out.
That means that at least some bankers at Morgan Stanley knew the extent of the selling that was likely and that Hwang's firm was unlikely to be saved, these people contend. That knowledge helped Morgan Stanley and rival Goldman Sachs avoid losses because the firms quickly disposed of shares tied to Archegos. Morgan Stanley and Goldman declined to comment for this article.
Morgan Stanley was the biggest holder of the top 10 stocks traded by Archegos at the end of 2020 with about $18 billion in positions overall, according to an analysis of filings by market participants. Credit Suisse was the second most exposed with about $10 billion, these sources noted. That means that Morgan Stanley could've faced roughly $10 billion in losses had it not acted quickly.
"I think it was an 'oh s---' moment where Morgan was looking at potentially $10 billion in losses on their book alone, and they had to move risk fast," the person with knowledge said.
While Goldman's sale of $10.5 billion in Archegos-related stock on Friday, March 26, was widely reported after the bank blasted emails to a broad list of clients, Morgan Stanley's move the night before went unreported until now because the bank dealt with fewer than a half-dozen hedge funds, allowing the transactions to remain hidden.
The clients, a subgenre of hedge funds sometimes dubbed "equity capital markets strategies," typically don't have views on the merits of individual stocks. Instead, they'll purchase blocks of stock from big prime brokers like Morgan Stanley and others when the discount is deep enough, usually to unwind the trades over time.
After Morgan Stanley and Goldman sold the first blocks of shares with the consent of Archegos, the floodgates opened. Prime brokers including Morgan Stanley and Credit Suisse then exercised their rights under default, seizing the firm's collateral and selling off positions on Friday, according to the sources.
In a wild session for stocks on that Friday in late March came another twist: Some of the hedge fund investors who had participated in the Thursday sales also bought more stock from Goldman, which came later to market at prices that were 5% to 20% below the Morgan Stanley sales. While these positions were deeply underwater that day, several names including Baidu and Tencent rebounded, allowing hedge funds to unload positions for a profit.
"It was a gigantic clusterf--- of five different banks trying to unwind billions of dollars at risk at the same time, not talking to each other, trading at wherever prices were advantageous to themselves," one industry source said.
Morgan Stanley largely exited its Archegos positions by Friday, March 26, with the exception of one holding: 45 million shares of ViacomCBS, which it shopped to clients on Sunday, according to the people. The bank's delayed disposal of Viacom shares has sparked questions and speculation that it held onto the stock because it wanted a secondary offering run by Morgan Stanley the week before to close.
Despite leaving some of its hedge fund clients feeling less than thrilled, Morgan Stanley isn't likely to lose them over the Archegos episode, the people said.
That's because the funds want access to shares of hot initial public offerings that Morgan Stanley, as the top banker to the U.S. tech industry, can dole out, they said.