Morgan Stanley's gold-linked notes low risk but low return analyst says; industry faces FDIC exclusion

By Kenneth Lim

Boston, Oct. 24 - Morgan Stanley's planned principal-protected notes linked to the price of gold pay an unusually generous amount even when the barrier is breached, but the probable returns are also low, said structured product analyst Suzi Hampson of Future Value Consultants.

Morgan Stanley plans to price zero-coupon capital protected barrier notes due Oct. 31, 2011 linked to the price of gold.

If the price of gold never goes above 150% of its initial level during the life of the notes, investors at maturity will receive par plus the final gold performance. Investors will receive at least par. If the price of gold exceeds the 150% barrier on any day during the life of the notes, investors will receive par plus an amount, to be decided at pricing, that will fall between $200 and $220 per $1,000 note.

Generous fixed payment

The amount that the notes will pay if the barrier is breached is unusually generous, Hampson said.

"It's a slightly different structure from what we see on a regular basis," she said. "You get one-for-one upside on the price of gold if the barrier is not broken, and if the barrier is broken then you get a fixed return between 20% and 22% depending on the pricing. And it's principal protected. Often you see barrier products where if you breach the barrier you only get the principal, but in this case you get the fixed payment, and in this case the payment is well above the risk-free rate."

The principal protection also gives the product a rather low-risk profile, Hampson added. Based on her assessment, the product would get a low "riskmap" score of 0.23 out of 10 using Future Value's models, where 10 is the highest risk.

Value less stellar

But Hampson noted that Future Value's riskmap score is weighted more toward market risks rather than issuer risk. In the product's value score, which is where the risk of an issuer default plays a bigger role, the Morgan Stanley note received only 3.37 out of a maximum of 10, she said.

"We've been looking at credit situations recently, and it's [Morgan Stanley] one of the higher credit spreads," Hampson said. "When we look at the value rating, we take into account the credit spread and remove a certain amount of basis points per year... and the longer the product, the larger the effect."

The probable returns from the notes are also on the lower end, she noted, with the most likely yield falling within 0 and 10%.

"You pay for capital protection by having low returns," she said.

Industry reacts to FDIC ruling

The Federal Deposit Insurance Corp.'s decision to exclude structured notes in its temporary liquidity guarantee program could encourage more structured certificates of deposit and a rethink of nomenclature, industry practitioners said Friday.

FDIC this week issued an interim ruling that structured notes will be excluded from the temporary liquidity guarantee program. The program was set up to guarantee senior debt issued by U.S. banking institutions until 2012. Non-U.S. banks are not covered under the program, and structured certificates of deposit, which are already insured by FDIC under most circumstances, are not affected.

The public has 15 days after the rule appears in the Federal Register - expected to be early next week - to comment.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.