(Bloomberg) — Morgan Stanley is keeping hold of some preferred shares that fell through the cracks of the transition away from Libor — the first test of how it will deal with $4.1 billion of the securities.
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The Wall Street bank is set to skip the first call option of a $862.5 million issue that has a fixed coupon of 7.125%. Friday was the last day the bank would have been able to announce a repayment before the call option’s exercise date on Oct. 15.
That’s the first call date among a batch of preferreds that became fixed-for-life after Morgan Stanley announced in April that some of the instruments would keep their original fixed rate instead of changing to a floating benchmark, angering some investors who missed out on the prospect of higher dividend payments.
Preferred shares have characteristics of debt and equity and are issued to help banks meet regulatory requirements on capital. They usually offer fixed coupons for a few years, and then switch to floating rates which were historically often tied to Libor — but the phase out of that rate in June left banks with the task of dealing with them.
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The market was surprised when Morgan Stanley’s preferreds shifted into fixed-for-life securities, especially as most of its peers transitioned to new floating rates based on SOFR, the Secured Overnight Financing Rate, taking advantage of federal laws. And skipping the call now may disappoint some investors who are holding a security that’s more susceptible to price swings when market yields change than floating preferreds.
Still, it’s typical for US banks to only replace their preferred shares if they can issue new ones at the same or lower rates to save on costs — meaning it probably makes economic sense for Morgan Stanley to hold onto the securities for now. Recent preferred share sales from Goldman Sachs Group Inc. and Citigroup Inc. had initial fixed coupons of 7.5% and 7.625%, respectively, higher than Morgan Stanley’s rate.
It would have been hard to replace the 7.125% preferreds at a level that was “truly and clearly economic,” said Spencer Phua, a senior credit analyst at Piper Sandler. “I don’t think we are going to depart too far from the economic-oriented framework” of preferred share call decisions, he said.
The issue was last quoted at about $25.40, above the level it could have been repaid, indicating that traders had priced in the skipped call.
A Morgan Stanley spokesperson pointed to the issue’s term sheet and declined to comment further.
Bloomberg Intelligence analyst Arnold Kakuda said Morgan Stanley would have been more inclined to call the preferreds if they hadn’t gotten stuck as fixed-for-life securities. Moving the securities to a floating rate tied to SOFR, in line with other Wall Street banks, would have given them an initial rate of almost 10%, according to calculations by Bloomberg.
“A call would’ve been much more likely if it did step up to a floater with a near 10% coupon,” said Kakuda. “But this is staying at 7.125%, which is about the going rate of a new preferred for a big bank.”
Morgan Stanley’s issue, which was first sold 10 years ago, is callable every three months from now on. The bank also has four other preferred stock series that became fixed-for-life in April.
–With assistance from Josyana Joshua.
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