July 2 (Bloomberg) -- Morgan Stanley may report a third straight loss because of accounting charges related to an improvement in the company’s own debt and the cost of repaying $10 billion in government bailout money.

The per-share loss probably will be 32 cents in the second quarter, according to the average estimate of 19 analysts surveyed by Bloomberg. The New York-based bank may report net income of $322 million, diverging from the per-share results because the company issued stock during the quarter.

Morgan Stanley, led by Chief Executive Officer John Mack, cut back principal investing and proprietary trading after losing money on bad bets, focusing instead on building its business of advising individual investors. The firm’s reduced risk-taking backfired in the first quarter, leading to lower trading revenue than larger rival Goldman Sachs Group Inc.

“Management has taken the necessary steps to shore up the firm’s capital base,” Glenn Schorr, an analyst with UBS AG, said in a June 29 report. Still, “the steps have led to meaningful dilution to the common shareholder, which will water down future EPS,” said Schorr, who expects the bank to report a second-quarter loss of 50 cents a share.

Goldman Sachs is expected to report net income of $2.39 billion, up 14 percent from a year earlier, according to the average estimate of three analysts surveyed by Bloomberg. On a per-share basis, profit is likely to be $3.39, down 26 percent from a year earlier and unchanged from the first quarter, according to the average estimate of 22 analysts.

Shares Decline

Morgan Stanley fell $1.37, or 4.8 percent, to $26.99 at 4 p.m. in New York Stock Exchange composite trading. The shares have climbed 68 percent this year. New York-based Goldman dropped 2.6 percent to $143.52.

Morgan Stanley’s profit will be reduced by a requirement that the company book a charge related to the narrowing of its own credit spreads, which increases the value of certain liabilities, analysts said. The firm will also have a charge of about $892 million for the cost of dividends on the government funds.

“As the operating environment has improved and Morgan Stanley’s credit spreads have tightened, the firm has and will have to take spread-tightening losses that will provide a headwind to earnings going forward,” Credit Suisse Group AG analyst Howard Chen wrote in a note on June 30.

Narrower Spread

The spread, or premium, that investors demand to lend to Morgan Stanley instead of the U.S. government has narrowed since reaching a record level in September and October, enabling the firm to raise money without government support.

The spread on Morgan Stanley’s $4.5 billion of 6.625 percent senior unsecured notes that mature in 2018 fell to 306 basis points, or 3.06 percent, yesterday from as much as 1,041 basis points, or 10.4 percent, in October, according to data compiled by Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Morgan Stanley and Goldman Sachs converted from the biggest U.S. securities firms into banks last year, and pledged to attract deposits, which were viewed as a cheaper and more reliable funding source than the bond market. They began relying on Federal Deposit Insurance Corp. guarantees in November to lure bondholders.

Morgan Stanley sold $4 billion of debt without an FDIC guarantee in May. That helped it meet a requirement set by regulators that enabled it to win approval to repay its $10 billion in Troubled Asset Relief Program money. Repaying the money enabled Morgan Stanley to shake off constraints on compensation and hiring.

FDIC Debt

On June 16, Morgan Stanley said it doesn’t intend to issue any more debt guaranteed by the government. The company had already sold about $24 billion of guaranteed debt between November and March.

Colm Kelleher, Morgan Stanley’s chief financial officer, said in April when the firm reported first-quarter results that the trading figures reflected the bank’s reduced appetite for risk. Chief Executive Officer John Mack said in the earnings statement that “we have focused on prudent stewardship of our balance sheet, capital and risk profiles.”

Chen at Credit Suisse earlier this week estimated a loss of 80 cents a share after previously predicting a profit of 40 cents. Oppenheimer & Co. analyst Chris Kotowski widened his loss estimate today to 94 cents from 20 cents.

Morgan Stanley may report $1.8 billion of losses tied to the improvement in the firm’s credit quality, according to Chen.

“While we ultimately expect the Morgan Stanley franchise to rebound from what was a difficult 2008, headline EPS will continue to suffer from mark-to-market losses on select balance- sheet exposures and debt valuation adjustments,” FBR Capital Markets wrote in a June 23 report. FBR estimated that Morgan Stanley will report a second-quarter loss of 30 cents a share.

To contact the reporters on this story: Josh Fineman in New York at jfineman@bloomberg.net; Christine Harper in New York at charper@bloomberg.net.

Last Updated: July 2, 2009 16:07 EDT