Morgan Stanley’s buffered jump notes on Euro Stoxx Banks benefit from favorable forward

By Emma Trincal

New York, Aug. 16 – Morgan Stanley Finance LLC’s upcoming 0% buffered jump securities with autocallable feature linked to the Euro Stoxx Banks index due Aug. 28, 2028 offer attractive terms due to a favorable relationship between the forward rate, which reflects anticipated future interest rates, and the dividend yield of the underlying, a structurer said.

The notes will be called at par plus 20% if the index closes at or above its initial level on Aug. 29, 2024, according to an FWP filing with the Securities and Exchange Commission.

If the notes are not called, the payout at maturity will be par plus 225% of any index gain.

Investors will receive par if the index falls by up to 20% and will lose 1% for each 1% decline beyond 20%.

Negative forward

The terms of the notes, including a high leverage multiple, the no-cap and a 20% buffer, appear remarkably attractive at first glance. A structurer explained how the compelling pricing was made possible.

“The dividend is so much higher than the swap rate, it makes the forward negative for this index, which allows for the high leverage,” he said.

Investors in structured notes do not receive dividend payments. Those are used by the bank in part to finance and hedge the position.

The index carries a dividend yield of 5.67%. The five-year Euro swap rate is 3.33%.

The structure can be broken down into two components. First, the issuer holds the position long in the index. Second the investor is long 2.25 call options and short a put struck at 80.

Cheaper leverage

This structurer elaborated on the “negative forward.”

The forward reflects the cost for the issuer to finance the long position in the underlying index. The cost of borrowing money to finance the position is the 3.33% swap rate over five years.

“The issuer has to pay that rate. But at the same time, it gets a huge dividend yield of 5.67%. The forward is negative because the dividend is much higher than the cost of carry,” he said.

The negative forward makes the net cost of buying the calls much cheaper as the puts sold by the customer have become more expensive.

“Since the customer is selling puts and buying calls, the negative forward offers a rebate, which the issuer can use to hedge the position and achieve that high level of leverage,” he said.

Buffer

Separately, the short put position reflects the 20% buffer pricing.

As long as the price does not get “in the money,” which means does not fall below the minus 20% strike, investors are protected on the first 20% losses, he said.

Some advisers shy away from large buffers over a five-year holding period, arguing that longer tenors give underliers plenty of time to recover from pullbacks and that money should be used otherwise.

“That’s in the eye of the beholder. For me, 20% may not be enough for this index,” the sellsider said.

Uncertainty

The global banking sector is going through mounting pressures as a result of tightening monetary policies and rising inflation.

The top holdings in the index are BNP Paribas SA, Banco Santander SA, ING Groep NV, Unicredit and Banco Bilbao Vizcaya Argentaria SA.

Spain is the top country with a 25% weighting. It is followed by France and Italy with a 21% and 20% weighting, respectively.

“I wonder why they have so much in Spain and Italy in there given the state of these economies,” a market participant said.

“In Europe, economic difficulties tend to create a lot of political pressures, which adds to the uncertainty.

“I like the 20% buffer because those large European banks can be risky. The Credit Suisse debacle showed that even a giant Swiss bank like Credit Suisse could fail. No one really knows what assets those large European institutions have in their books.”

But the upside was attractive.

“If you’re really bullish, getting 2.25x the upside without a cap is a very attractive tradeoff,” he said.

The CRE factor

Ferenc Sanderson, executive adviser at Visual-Alpha Co. Ltd., compared risks in the banking sector between the U.S. and Europe.

“While the economy is slower in Europe than in the U.S., European banks don’t have the headwinds of commercial real estate like U.S. banks,” he said.

“Credit Suisse was a big story, but the crisis was quickly resolved when they were absorbed by UBS.

“European banks don’t have this big exposure to bad commercial real estate loans. They don’t have as much risk on their books. So, I think the banking sector in Europe is likely to remain stable, at least compared to the U.S.”

The notes are guaranteed by Morgan Stanley.

Morgan Stanley & Co. LLC is the agent.

The notes will price on Aug. 23 and settle on Aug. 28.

The Cusip number is 61775HC70.

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