(Bloomberg) --Morgan Stanley and
The Wall Street banks are reviving dormant formats to raise capital with a lot more duration than usual, playing into bets that the Federal Reserve is on the cusp of an easing cycle.
In one of the most striking examples, Morgan Stanley this week sold preferred shares with a fixed-for-life rate rare for a major bank, a feature that makes the security vulnerable to rate gyrations indefinitely. The same day a deal from
Speculation that the Fed may end up cutting interest rates faster or deeper than planned has led investors to bet on duration-heavy assets that typically notch price gains when rates are falling, and it's paving the way for deals that all but vanished in recent years.
"Issuers are taking advantage of the demand," said Mark Lieb, founder and CEO of Spectrum Asset Management.
For investors, the bet has delivered early gains. Morgan Stanley's issue is trading at an indicated price of 103% of face value;
But down the road, investors accepting extra duration risk could face losses under US policies that may fan inflation. Preferred shares are subordinated securities that count toward a bank's regulatory capital.
Bloomberg contacted Morgan Stanley for comment, while a representative for
Banks are bringing back duration risk to preferred shares as conviction runs high the Fed will unleash its first quarter-point cut in September. A second cut is expected by the end of the year, based on data compiled by Bloomberg. Two months ago, money-market odds pointed to single cut this year.
Even though they are perpetual, issues from big banks nowadays tend to reset to a floating rate after their first optional repayment date, making their prices much less sensitive to moving interest rates. And the time to the first call date is usually only five years, limiting volatility.
While short term rates are set to be pushed down by Fed cuts, long term rates aren't expected to follow suit. Traders betting on the return of Donald Trump as US president next year expect his policies to drive up inflation, which would force up yields on longer-dated instruments. This widening gap between short and long-term rates, a key part of the so-called "Trump trade," is called steepening.
"A Trump election win may steepen the yield curve which may lead to higher long-term rates," said Arnold Kakuda, senior financials credit analyst at Bloomberg Intelligence. "If more banks believe that happens, they may want to issue more longer duration fixed for life."
A chaotic US election, including the assassination attempt on Trump, and potential for more market volatility is one reason why Spectrum's Lieb said he passed on both the Morgan Stanley and
"There's too much uncertainly," said Lieb. "We still think it's safer to have shorter duration."
Brian McArdle, portfolio analyst at GW&K Investment Management, is also leery of using preferred shares to make rate bets. "We always believe interest rates are very difficult to forecast," he said.
Meanwhile, Morgan Stanley sold a series packaged in a way that could be sold to retail clients, the first time this was done in almost two years by a Big Six lender. This is referred to as the $25 par market to differentiate it from the institutional investor-focused $1,000 segment.
The fixed-for-life rate has been deployed previously this year only by regional banks.
Morgan Stanley originally guided for $250 million before setting the final size to $1 billion. That kind of demand may spur copycat deals.
"Most will probably stick to NC5, but to diversify, they may look at other ways," Kakuda said. "The door has been cracked open so why not?"
