Morgan Stanley's CMT floaters backed by Altria notes feature trust entity issuer, swap payout

By Emma Trincal

New York, Aug. 11 - Morgan Stanley is bringing to the market an innovative way to issue a structured note with its 10-year Constant Maturity Treasury index-linked securities backed by Altria Group, Inc. notes and issued by a trust entity, sources said.

In this transaction, Morgan Stanley, which is the underwriter, gives investors access to CMT-linked returns by entering into a swap agreement with the issuing trust, another factor that adds uniqueness to this deal, they noted.

Morgan Stanley plans to price $10 million of CMT-linked series 2010-01 trust units due Aug. 6, 2019 backed by Altria notes, according to a 424B5 filing with the Securities and Exchange Commission.

The trust units are specifically backed by Altria's 9.25% notes also due Aug. 6, 2019, and the issuer is CMT Linked Trust Units Series 2010-01.

The coupon will be 4% for the first year. After that, the rate will be equal to the 10-year CMT index, up to a maximum coupon of 15%. Interest will be payable semiannually and cannot be less than zero.

The payout at maturity will be par.

The trust units will be called if the underlying securities are called.

A distinct deal

"This is not a typical structured note," a New York sellsider said. "And it's very different from when you have issuers like AB Svensk [Exportkredit] or Eksportfinans [ASA], who are the entities that actually issue the notes. Here the notes are not even issued by Altria. It's a trust that owns the notes and issues them to the investors."

According to the prospectus, while the underlying notes paying 9.25% are issued by Altria, the units sold to investors are issued by the trust. "Neither the underlying security issuer [Altria] nor the underlying security guarantor [Philip Morris USA Inc., Altria's parent company] is participating in this offering and neither has any obligations under the units," the prospectus stated.

"Altria may not even have any involvement in that. It could be Morgan Stanley buying Altria's notes on the secondary market and putting it in a trust," the sellsider said. "It's a way to deliver the structure payout linked to the CMT with Altria credit, without Altria being involved."

Altria is rated investment-grade with a Baa1 rating from Moody's Investors Service, a BBB rating from Standard & Poor's and a BBB+ rating from Fitch Ratings.

The swap

The trust receives interest on the notes and passes through interest to the investors in the trust units subject to payments made by Morgan Stanley - the swap counterparty - under the derivative agreement, the prospectus said.

In the interest rate swap agreement between the trust and Morgan Stanley, the trust makes semiannual interest payments to the bank for 9.25% per year while the trust receives payments from the swap counterparty based on CMT rates.

"Altria is issuing a 10-year CMT payout to the investor but doesn't want to pay CMT floating rates. They just want to pay the 9.25% fixed-rate note," explained Michael Iver, former structurer at JPMorgan. "Altria is issuing the 9.25% note to the investor but indirectly."

He said that the trust "swaps" the 9.25% coupon for the CMT return and that the derivative agreement was how the trust was able to transform a fixed-rate payment into a floating rate based on CMT levels.

"Morgan Stanley is doing a couple of things. Most likely they're doing some bond underwriting for Altria and they're also acting as a swap counterparty. This is very typical of corporate finance," Iver said.

Investors' motivation

Iver said that investors may find the swap and trust structure attractive as a way to obtain diversification of names in a portfolio.

"It could be a number of reasons. Maybe investors like the CMT payout and they also want exposure to Altria," he said.

"The derivatives contract allows investors to get a complex return with some credit exposure to Altria credit with CMT-linked returns," said the sellsider. "The swap there gives the trust a return that's different from the return of the Altria bonds. By entering a swap agreement, you change the return payout offered to investors.

"Morgan Stanley received Altria's bonds' returns and pays CMT-based returns to the trust. The trust in exchange pays the CMT returns to the investors."

Risks

But some sources were more skeptical about the complex structure.

"In general, a firm uses an external issuer so that they don't have to use their own balance sheet," said a second New York sellsider. "I'm not sure why they're doing it here, but if this was to become a market trend, it could be a little scary as it might suggest that firms are finding it more difficult to get the funding levels they need in order to give their clients attractive terms," he added.

"Clients are subject to a double risk: the credit risk and the counterparty risk in addition to the normal market risk," the first sellsider said.

The notes (Cusip 02209SAJ2) will price and settle in August.

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