Morgan Stanley's trigger PLUS linked to S&P 500 are trade-off between protection, credit risk

By Emma Trincal

New York, June 19 - Morgan Stanley's 0% trigger Performance Leveraged Upside Securities due July 2018 linked to the S&P 500 index offer up to 40% downside protection through a final barrier, but investors are subject to the issuer's credit risk for five years.

The payout at maturity will be par of $10 plus 130.5% to 140.5% of any index gain. The exact participation rate will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 40% and will be fully exposed to the index's decline if it falls below the 60% trigger level.

Fair

"This deal indicates that people are willing to forgo dividends to get some protection. It's a barrier, so it's not a real protection. But you get a little bit of leverage, which is good. And there is no cap. It seems like a pretty fair deal," an industry source said.

"You're giving up dividends for leverage.

"This barrier has some value. The question is, What value does it have for you?

"Some people would rather not be exposed to Morgan Stanley for five years and get rid of the barrier. That's a personal choice."

The notes are unsecured obligations of Morgan Stanley. As a result, payments are subject to the credit risk of the issuer, according to the prospectus. Morgan Stanley is rated A- by Standard & Poor's and Baa1 by Moody's.

The trade-off consisting of getting contingent protection at the price of taking on credit risk exposure for five years may not be appealing given Morgan Stanley's creditworthiness, according to a market participant.

"Five years is still a long time with Morgan Stanley, honestly. It's a triple B entity, maybe single A depending on the rating agency. Why would you want to stay invested for five years?" this market participant said.

Issuer's credit risk

"OK, the protection is fine. But I would rather buy futures in order to get the 1.3 times leverage and be more flexible instead of going out five years and be locked in. I'd rather skip the barrier, buy directly the market and outperform with some calls," the market participant said.

"Sure, in some ways the barrier is attractive. It's low; it's European. But the five-year term is way too long."

He was referring to a "European" barrier that gets exercised at the end of the term, as opposed to an American barrier option, which is exercised any time during the term of the contract or the life of the notes.

"You have to take into account the credit risk. With Morgan Stanley, it's something to consider," he added.

"They're not going to go broke, sure. But that's also what we used to say about Lehman Brothers.

"I know that structured notes are sold as buy-and-hold instruments. But liquidity has its value. If people are happy to buy and hold, then let them hold it for me!"

Personal choice

The industry source said that technically, an investor can "replicate everything" with futures or options.

"I can buy call spreads and get the leverage, but I would have to buy a premium. The premium is subsidized by the coupon I would get from the Morgan Stanley note. If I did that, I wouldn't care much about the protection," he said.

"This note gives you some downside protection. The flip-flop of that is that you are taking the Morgan Stanley credit risk. Do you want the protection or the credit risk? It's in the eye of the beholder.

"You can replicate everything without going through Morgan Stanley. But are you in a position to do that?"

Morgan Stanley & Co. LLC is the agent.

The notes will price in June and settle three days later in July.

The Cusip number is 61762E745.

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