Morgan Stanley's buffered PLUS linked to S&P 500 offer attractive terms but with credit risk

By Emma Trincal

New York, Aug. 31 - Morgan Stanley's 0% buffered Performance Leveraged Upside Securities due March 2014 linked to the S&P 500 index are designed for investors willing to take on more credit risk in order to improve the terms and potential payout, said Suzi Hampson, structured products analyst at Future Value Consultants.

"If you want to expose yourself to credit risk as opposed to market risk, this product is a different way of generating higher returns," she said.

The payout at maturity will be par of $10.00 plus double any index gain, up to a maximum payout of $11.50 to $11.90 per note, according to an FWP filing with the Securities and Exchange Commission.

The exact cap will be set at pricing. For its report, Future Value Consultants assumed a cap of 18%.

Investors will receive par if the index falls by up to 10% and will lose 1% for each 1% that it declines beyond 10%.

Despite a relatively attractive cap and the existence of a buffer, the 5.20 overall score of the product is far below than the 7.32 average score for the same product type, she said.

The overall score represents Future Value Consultants' opinion on the quality of a deal. It is the sum of the return and price ratings.

Riskmap

Future Value Consultants assesses the risk of a product with its riskmap. Established on a scale of zero to 10, the riskmap is the sum of two components: market riskmap and credit riskmap.

The 4.58 riskmap for these notes is higher than the 4.11 average riskmap for similar products, which would be other leveraged products with or without a buffer. The "all-product" category, or notes recently rated by Future Value Consultants, have just about the same riskmap at 4.10.

On the other hand, the credit riskmap for the Morgan Stanley notes suggests a higher level of credit risk than the average. The notes have a 2.08 credit riskmap, which is more than the 0.99 average for the same product type and 0.75 for all products.

"The score suggests that the additional risk you're getting comes from credit risk," Hampson said.

"It's a combination of two things: a one-and-a-half-year term, which seems longer than the average leverage product we've seen recently, and the credit ratings of this issuer," she said.

The one-year credit default swap spread is 200 basis points for Morgan Stanley. By comparison, JPMorgan's spread is 34 bps, Citigroup's 91 bps, Bank of America's 96 bps and Barclays' 116 bps, she said.

"This issuer has pretty wide CDS spreads, wider than most others, which will have an effect on the credit riskmap. The greater risk comes primarily from the issuer," she said.

"We can't get the funding rates, so we have to use indicators such as credit ratings or CDS spreads. We could be on the harsh side, but that's all we can do. We use the same parameters with all issuers, so that's consistent.

"For an investor, it might be difficult to know what terms they should be getting for the additional risk.

"If you look at an income product, you can get an estimate of funding. Coupon-bearing notes can be compared with other notes or bonds from the same issuer. But this is paying you participation in the index, so you can't really compare it to the plain vanilla paper."

The market riskmap of 2.50 is lower than the average for the same product type at 3.12. It's also below the 3.34 average market riskmap for all products.

"The market risk is lower. First we've got the S&P compared to other leveraged products tied to more volatile indexes or funds," she said citing the Euro Stoxx 50 index, the iShares MSCI Emerging Markets index fund and other various iShares funds as examples.

"Second, we have this buffer and we're comparing it to other products that may or may not have one. Or they may have a barrier."

Return score

Future Value Consultants measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions: neutral assumption, high- and low-growth environments and high- and low-volatility environments. A risk-adjusted average return for each assumption set is then calculated. The return score is based on the best of the five scenarios.

The notes, with a 5.95 return score, show a less attractive risk/return profile then the average product.

Leveraged notes have an average return score of 7.26. For all products, the average is 6.55.

"The return score measures the potential return with the amount of risk you're taking on," she said.

"You assess how likely you'll get a return versus losing capital. The credit risk here obviously is having an effect."

Price

Future Value Consultants measures the market value of the underlying components of the product on a scale of zero to 10 with its price score. Calculated as a percentage of the initial investment, the score gives an estimate of the fees taken per annum. The lower the score, the lower the value offered to the investor.

With a 4.45 price score, the notes offer less value than their peers (7.38) and than the general average (6.55).

"We have a lower price score, which is what we expect with the lower credit score," she said.

"If you had the same terms with a different issuer, this rating would be much more.

"All it shows is that you have to spend more on the options if you want to provide more value when you have a lower credit."

Hampson said that this leveraged buffered product is "pretty standard." The difference is the more elevated credit risk.

"For most structured products, it shouldn't come as news to investors that they should really consider the credit. When you're looking at higher-funding issuers, it's definitely something you should be thinking about," she said.

"The higher-risk issuer is not necessarily a bad choice as long as you understand the risk. It's a way to change the nature of the risk and to get perhaps better terms with less exposure to market risk. You just have to be aware of credit risk."

Morgan Stanley & Co. LLC is the agent.

The notes were expected to price in August and settle in September.

The Cusip number is 61755S586.

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