Morgan Stanley’s trigger gears tied to Stoxx Europe 600 Banks offer access, uncapped gains

By Emma Trincal

New York, Aug. 28 – Morgan Stanley Finance LLC’s 0% trigger gears due Aug. 31, 2021 linked to the Stoxx Europe 600 Banks index offer an attractive upside for those willing to invest in a sector of the European equity market that is not easily accessible for U.S. investors.

If the index finishes above the initial level, the payout at maturity will be par plus the upside gearing of between and 3.5 to 3.55 times the gain, according to an FWP filing with the Securities and Exchange Commission.

If the index finishes at or below the initial level but at or above the downside threshold, 75% of the initial level, the payout will be par.

Otherwise, investors will be fully exposed to the index decline.

Leveraged exposure

“The dividend is a substantial give-up,” said Jonathan Tiemann, president of Tiemann Investment Advisors, LLC.

“You have the usual issues with credit risk and lack of liquidity.”

The underlying index tracks the performance of companies from the European Banks sector. Its dividend yield is 3.22%.

“But if you were determined to have exposure to Europe and to that specific sector in Europe, you might as well juice it with leverage, which is what this note definitely does with 3.5 times.

“It’s a way to turbocharge a bet on European banks,” he said.

Access

Investors in a fund replicating the Stoxx Europe 600 Banks index would receive approximately 10% in dividends over the three-year investment period, a sum noteholders are not eligible to receive.

But such fund – the iShares Stoxx Europe 600 Banks UCITS exchange-traded fund – is listed in Germany and is not available to the U.S. market.

Access therefore is one of the products’ benefits.

“It’s a way to get exposure to this European sector,” he said.

Bull play

The “dividend problem” could be easily resolved with the high leverage multiple but not always, he noted.

“If the performance is strong, the leverage will more than offset what you’re giving up in dividends,” he noted.

“Obviously this is a bullish structure. If you’re down, you have the 25% protection. But the dividends may offer a better deal depending on how far the index declines.”

Yield, tenor

The three-year tenor was attractive, he noted.

“It’s the dividend you give up that makes it possible to have a structure with that much leverage and no cap for a three-year maturity,” he said.

Most deals with a similar upside on the S&P 500 would require at least a five-year tenor, based on data compiled by Prospect News.

The S&P 500 index yields 1.75%.

“It gives you an idea of how much a difference a yield does make,” he said.

“Three-year, no cap isn’t bad. You’re definitely taking the three-year commitment though. I wouldn’t blame anyone for hesitating on that account. But it’s true that it’s not like it’s a five or seven year.

“If you want access to this market and if you’re willing to hold the notes for three years, this is not a bad deal at all. I’ve seen worse.”

Global banking

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, said the notes would not meet his criteria.

“The European banking sector is not an area where I would want to invest, especially over the next three years,” he said.

Chisholm said he expects a weakening of the U.S. economy within the next two years. Hence, the banking sector is likely to be vulnerable in a recession.

“Right now the U.S. economy is strong. But I’m seeing some warning signs. I do foresee some big issues in the next 12 to 24 months in the U.S. If that’s the case, if we have a recession it will obviously spill over into Europe during the same time,” he said.

“If we go into a recession, you don’t want to have any exposure to banks in general. It’s a global economy. All big banks are global.”

Junk issues

Some of the “warning signs,” Chisholm is concerned about pertain to the high-yield bond market.

“A lot of paper is set to mature in the next year or two,” he said.

“With interest rates rising, companies may have a hard time rolling their debt at levels they can afford.

“Maybe they won’t be able to refinance at higher rates or maybe they won’t be willing to. You could imagine a scenario in which bond funds would freeze redemptions as we’ve seen in 2008. That could precipitate a sell-off, which could have repercussions not just on the bond market but in the equity markets as well.”

Protection, liquidity

For this reason, Chisholm said he was not comfortable with the 75% barrier seen in the notes.

“I don’t like barriers. If I was interested in this note I would want a buffer. It’s fine to have a 25% barrier. But if the index is down 26%, you’re down 26%, you’re not down 1%.

“Barriers are not at all appealing to me.”

But more problematic was the overall investment theme of the product.

“When the economy fails, banks get hit first and suffer the most. We’ve seen that during the Great Recession. So, I wouldn’t touch that sector,” he said.

“What I want right now is to be liquid. When the market drops, liquidity is key. With cash, you have the ability to purchase at the right price.”

The notes will be guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC and UBS Financial Services Inc. are the agents.

The notes will price on Wednesday and settle on Aug. 31.

The exact upside gearing will be set at pricing.

The Cusip number is 61768R716.

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