Morgan Stanley's $49.71 million notes linked to CPI target income seekers, inflation hedgers

By Emma Trincal

New York, April 20 - Morgan Stanley's $49.71 million issue of fixed-to-floating notes due April 25, 2023 linked to the Consumer Price Index was well received due to investors' strong appetite for yield as well as growing bets on Federal Reserve rate hikes, sources said.

The coupon will be 6.5% for the first two years. After that, it will be equal to the year-over-year change in the Consumer Price Index plus 200 basis points, subject to a minimum of zero and a maximum rate of 8%. Interest is payable monthly, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par.

Yield rush

"People are desperate for yield right now, so a 6.5% coupon for two years is very attractive," a sellsider said.

"This is an even better deal if you expect that the Fed will raise rates but not right away. If you're right, then this is a great deal."

Lisa Smith, vice president in charge of structuring at Bankers Financial Services LLC, agreed that a 6.5% rate is appealing to investors.

"I was talking to insurance agents and they were telling me that the most you can get on a fixed annuity right now is 4%. They were very interested in structured products. They had a hard time believing that you could get a coupon above 4%," she said.

"The appetite for yield is very strong."

Fed hike bet

The 12-year notes also represent a long-term bet that inflation will be on the rise for some time, the sellsider said.

"The European Central Bank raised rates recently, and the market anticipates that the Fed won't keep interest rates at zero for ever.

"But the question is when. People buying those notes don't see a rate hike in the next 18 months."

Too much, too little

The prospectus stated two main risks with the product: too little inflation and too much of it.

If inflation remains low after the first two years, the coupon paid on the notes may be less than the 200 bps spread. Worse, if there is deflation, investors may end up not earning any interest at all as the CPI could decline by more than the spread, the prospectus warned in the risk section.

Inversely, if inflation accelerates after the two initial years, investors face the risk of earning less with the notes than with other notes as their coupon is subject to an 8% cap.

"I think that could be the main problem," the sellsider said, talking about the second scenario of high inflation.

"For the next two years, 6.5% is great. But suppose you get double-digit inflation in five years. It may not look so good to be capped then."

The agent was Morgan Stanley & Co. Inc.

Fees were 2.25%.

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