The Counterintuitive Upside to Morgan Stanley’s Debt Issues

The few big banks left standing are again starting to raise money from the public. Last week, for instance, Morgan Stanley offered $750 million in notes due in 2011, as well as Hong Kong dollar notes due in 2012 and various other issues.

So, Morgan Stanley is taking on more debt. Aren’t banks supposed to reduce their liabilities? But here’s a glass-half-full view: Institutions like JP Morgan and Morgan Stanley are now confident enough that their bonds will sell and that buyers won’t run away at the thought of balance sheets potentially sagging under the weight of toxic securities.

True, the new willingness to borrow doesn’t necessarily mean that financial companies have grown stronger. A big chunk of the debt is backed by Uncle Sam, which guarantees it under the FDIC’s Temporary Liquidity Guarantee Program. Last month, Morgan Stanley sold $4.5 billion of FDIC-guaranteed global notes.

Morgan Stanley’s new $750 million debt is to be consolidated with a $2.5 billion package of 3.25 percent notes the firm issued in December, which was also guaranteed by the FDIC. With the new issuance, the principal outstanding of this type of note will increase to $3.25 billion, all carrying the “full faith and credit of the United States,” as the prospectus puts it.

Thanks to the FDIC guarantee, the notes are rated triple-A by Moody’s, Standard & Poor’s and Fitch. The government guarantee makes a significant difference for the rating — the issuer itself has a lower rating. The separate Hong Kong dollar floating rate notes are also guaranteed by the FDIC.

Morgan Stanley may be one of the better positioned institutions, although you’ll recall that only a few months ago its survival was at stake, and no one knows whether it will maintain its independence.

Could the notes be sold without US backing? Unlikely. Then again, the very fact that banks are willing to test the waters with these and other offerings may be a sign that conditions are becoming more normal, at least for a lucky few.