Morgan Stanley’s $4.28 million RevCons tied to Swiss stocks have innovative ‘lock-in’ feature

By Emma Trincal

New York, Sept. 15 – Morgan Stanley’s $4.28 million of 5% worst-of fixed coupon lock-in RevCons due Sept. 18, 2017 linked to the worst performing of the shares of Credit Suisse Group AG, Adecco SA and Novartis AG offer an “innovative” feature giving investors a chance to acquire full principal protection at maturity under certain conditions, a market participant said.

Interest is payable annually.

A lock-in event occurs if, on any Wednesday over the life of the notes, the closing price of each underlying stock is greater than or equal to its respective lock-in price, 103% of its initial price, according to a 424B2 filing with the Securities and Exchange Commission.

If a lock-in event has occurred, the payout at maturity will be par plus the final coupon.

If a lock-in event has not occurred and each stock finishes at or above its downside threshold level, 80% of its initial price, the payout will be par plus the final coupon.

If a lock-in event has not occurred and any stock finishes below its downside threshold, investors will be fully exposed to the decline of the worst-performing stock.

With this structure, investors have a 20% contingent protection through the 80% barrier, but they may also have full protection should the lock-in event occur, he noted.

Pricing

“It’s interesting. I don’t know how that’s priced. I’ve never seen anything like that,” a market participant said.

Increasing the risk or lowering the coupon would be the natural ways to finance the advantageous term, he explained.

“They had to take something out,” he said.

Worst-of notes are designed to boost the yield in general as this form of payout carries more risk.

“In terms of the coupon, well, 5% is not a great coupon, especially if you take the worst of. The structure makes sense in terms of where the value is,” he said.

Low hurdle

At the same time, one appealing aspect of the lock-in feature is how likely the event is to occur, he said.

“Frankly, I think it can easily be triggered even with a worst of. It’s less likely to happen with a worst of, but it’s still very likely because it’s only 3% over the initial price. That’s not a high hurdle. Plus you have a weekly observation date for two years,” he said.

He concluded that lowering the coupon was one of the main means by which the issuer had been able to price the lock-in.

“Five percent is low for a worst of. Maybe without this feature you would have received an 8% ... just an example.”

Low correlation

Another factor is the choice of the three underlying stocks.

“They put in there three stocks that are not correlated. You have a bank, a human resources service provider and a health-care company,” he said.

“The non-correlated aspect of the deal definitely helps the structure. The possibility of one stock being really bad is higher because you’re dealing with three different industries. It helps because it lowers the chances of getting this lock-in.”

Overall, the way the structure was priced is really “interesting,” he said.

Innovative

“This lock-in is an attractive concept. Five percent is a nice coupon when you have the potential to get full principal protection without the hurdle being too high,” he said.

“This is a nifty principal protection they got built into the notes.

“I give [Morgan Stanley] lots of credit for being creative and coming to market with something innovative.”

Marketing the notes, however, may not necessarily be easy.

“I would say ... the whole ‘Wednesday’ thing ... in our shop ... that would never fly. It looks too much like a bet. It’s got that gimmick feel to it,” he said.

No RevCon

Steven Foldes, vice chairman at Evensky & Katz/Foldes Financial Wealth Management, would not consider the notes because he usually doesn’t invest in reverse convertibles. To him, the lock-in feature makes no difference.

“This is something that we would not do categorically. We are not in the individual stock business. We believe in asset allocation. We just don’t get as granular as individual stocks,” he said.

“It’s exacerbated by the fact that it’s three Swiss [stocks], not U.S. stocks.

“There may be a protection, other bells and whistles ... but the fact that it is a reverse convertible with a worst of is something we wouldn’t even look at. You may end up potentially taking a big loss, and your upside is limited to the coupon.”

If anything, the lock-in is a negative in his view, as he pointed to the complexity of this particular term.

“It’s a tough one to understand, a tough one to sell. At $4.28 million, it’s a small note. It looks like they did this for a specific client,” he said.

Morgan Stanley & Co. LLC was the agent.

The fee was 1%

The notes (Cusip: 61761JK81) priced on Sept. 9.

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