Morgan Stanley - Is 6.875% Attractive?

Dec.10.13 | About: Morgan Stanley (MS)

On Friday, December 5, Morgan Stanley (NYSE:MS) issued $850 million of preferred stock. The Series F preferred is a non-cumulative, fixed-to-float issue.

Morgan Stanley is a leading global financial services firm providing a wide range of investment banking, securities, investment management and wealth management services. The Firm's employees serve clients worldwide including corporations, governments, institutions and individuals from more than 1,200 offices in 43countries.

The details of the offering are:

(Prospectus and pricing sheet)

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Note that these have a "regulatory capital call" provision. A "Regulatory Capital Treatment Event" means the good faith determination by Morgan Stanley that there is more than an insubstantial risk that Morgan Stanley will not be entitled to treat the full liquidation preference amount of $25,000 per share of Series F Preferred Stock then outstanding as "Additional Tier 1" capital (or its equivalent) for purposes of the capital adequacy guidelines of the Federal Reserve Board.

Prior to looking at the preferred stock's relative value (within the MS complex and against peers), just a couple of thoughts on the state of the industry and Morgan Stanley in particular.

In the "heady" years (2005-2007), banks - especially investment banks - were run with significant leverage. It was the unwinding of that leverage that added fuel to the fire. The following graph shows the "leverage path" since the crisis:

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As is evident in the graph, the primary (remaining) players have de-levered and the two remaining (large) investment banks - Morgan Stanley and Goldman Sachs (NYSE:GS) are now levered near the same multiple as global banks such as JPMorgan (NYSE:JPM) and Citigroup (NYSE:C).

Similarly, the tangible common equity ratio (a measure of financial strength which shows the tangible book value as a percentage of tangible assets) of the remaining investment banks is similar to the global banks as well:

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Ultimately, these two charts combined show that the investment banks have de-risked and are now more conservative financial institutions. This is also reflected in their average value-at-risk ("VAR"):

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This is partially the reason for the significant returns realized by investors over five years:

MS Chart

MS data by YCharts

And year-to-date:

MS Chart

MS data by YCharts

And on to the preferred valuation. The table below shows all the Morgan Stanley preferreds that are available to investors ($25 par):

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As the table shows, the new issue is the "cheapest" in the complex. While it does not trade at the discount others do, at/near par it still has a yield advantage to the others (yes, I realize that most are cumulative TRuPs).

So we have established that it is "cheap" to other Morgan Stanley preferreds, but what of the preferreds of the following peer group:

  • Goldman Sachs,
  • JPMorgan, and
  • Citigroup.

As the following table shows, it is not "cheap" to peers, out-yielding only the JPM Ds.

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I would, however, say that it should trade inside of (lower yield than) Goldman, given the business profile and diversity of revenues. Similarly, it should trade wide to (higher yield than) JPM for the same reason. Conceptually, it should trade wide to Citi as well, but Citigroup is still "finding their footing" and trades at a discount.

Bottom Line: I like the new Morgan Stanley Fs versus their own name and think it is a decent addition to a preferred or income portfolio, but I might look to the Citigroup Cs for the yield pick-up and the discount price. For the time being, I would also take my exposure to Morgan Stanley in the preferreds as the equity has run up significantly and the taper and regulatory induced market changes (less liquidity, less trading...) coming down the road could impact valuations and revenue growth. Ultimately, the answer to the title question is "Yes, it is attractive, but opportunities elsewhere could be more compelling".

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article is for informational purposes only, it is not a recommendation to buy or sell any security and is strictly the opinion of Rubicon Associates LLC. Every investor is strongly encouraged to do their own research prior to investing.