Morgan Stanley’s $78.15 million autocallables on dollar/euro is top FX deal this year so far

By Emma Trincal

New York, June 24 – Morgan Stanley priced last week $78.15 million of 0% autocallable currency-linked notes due June 25, 2020 linked to the performance of the U.S. dollar relative to the euro.

Out of 40 deals totaling $219 million, this is by far the biggest FX deal so far this year, according to data compiled by Prospect News.

Last year’s top currency deal was brought to market by Goldman Sachs Group, Inc. It was $82.1 million of contingent coupon currency-linked notes tied to a basket of currencies relative to the euro. The basket included equal weights of the Canadian dollar, the Mexican peso, the U.S. dollar, the British pound and the Norwegian krone.

Big

“This is a huge size. It could be an institutional investor,” an industry source said about the Morgan Stanley offering.

“Autocallable FX deals are quite common in Europe, but not here.”

The notes offer a return linked to the positive performance of the dollar relative to the euro, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will automatically be called at par plus a call premium of 8% per year on any semiannual call observation date beginning after one year if the currency return is greater than or equal to the 8.5% strike level.

If the notes are not called and the final currency return is greater than or equal to the strike level, the payout at maturity will be par plus the 40% maturity date premium return.

If the final currency return is less than the strike level but greater than or equal to negative 10%, the payout will be par.

If the final currency return is less than negative 10%, investors will lose 1.1111% for each 1% decline beyond the 10% buffer, subject to a minimum cash settlement amount of 85% of par.

Dollar bulls

“Traditionally, FX deals have been difficult to price in the U.S.,” a market participant said, pointing to the unusual size.

“We had a dollar rally in the first quarter, but then the euro came back. The market sentiment right now is that the dollar pullback is overdone and that we should see some dollar strengthening.

“The U.S. economy is doing well. Ultimately the Fed will hike rates. That’s another factor.

“Meanwhile the potential Greek exit is putting some pressure as it could ignite another European crisis, further weakening the euro.”

The industry source agreed with this thesis, saying that the size of the deal reflects an increasingly popular view.

“The Greece crisis is the short-term thing, but you also have the European Central Bank’s QE that still has another year to go. At the same time, the European economy is not particularly thriving,” this source said.

“The other side is the U.S. The U.S. economy is in good shape. The Fed is expected to hike interest rates. When exactly? It’s still unknown but certainly sooner than the ECB.

“Both factors are calling for a stronger U.S. dollar relative to the euro.”

Autocall

From a pricing standpoint, the structure type employed makes sense, according to the market participant.

“There aren’t that many autocallables on currencies, but we’ve seen some volatility in eurodollars. This gives autocallable structures, which sell volatility, attractive pricing,” he said.

“It’s just another way to play with the increased FX volatility around the euro/dollar currency pair.”

Structure

The autocallable format differs in many ways from the equivalent product in equity-linked investments, the industry source said. The notes offer an obvious appeal given the bid, he said. But at first glance, the upside benefits are not easily discernable.

“The attractiveness is the 8% yield per annum. You can’t be called before the end of the first year, but you could get 8% after one year and then 16% after two up to 40% at maturity,” he said.

“People are buying it for the yield. It fits the bill for those autocallable buyers who want to be called early.

“The downside is an obvious benefit for any investor. Your losses are capped at 15%.”

But the call strike is unusual, he noted.

“It’s set 8.5% higher than the initial price. We’re used to seeing call thresholds at the initial price. In addition, the 8% call premium is not at the same level as the strike but half a point lower. You can certainly outperform but not on the short term. You need to be invested more than a year.

“That’s the interesting part. An autocall usually is designed for short-term players. This one will give you a better shot at outperforming if you don’t get called too soon.”

Still, the structure offers benefits over the equivalent long dollar/short euro FX trade.

“It allows you to get your 8% annualized return based on the same 8.5% strike. That strike stays the same each year,” he said.

“Longer term, you may be able to accumulate more yield than if you were rolling the trade with a new strike each time.

“It’s just a little bit different from the typical purpose of an autocall, which is to exit early.

“Maybe they’re targeting a client who has a long-term investment horizon ... someone who wants it for the 8% annually or perhaps as a hedge for an existing euro exposure.”

The notes (Cusip: 61760QGM0) priced on June 18.

The initial exchange rate was 1.14030.

Morgan Stanley & Co. LLC was the agent.

The fee was 2.67%.

© 2015 Prospect News.
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