Friday, January 18, 2013

Structured Product Issuers Under Pressure to Disclose Estimated Value

By Tim Husson, PhD and Tim Dulaney, PhD

According to securities law firm Morrison & Foerster's Structured Thoughts newsletter (PDF), the SEC may soon require issuers of structured products to disclose the estimated value of the product on the front page of the prospectus.  From the newsletter:
Elaborating on the [SEC's] sweep letter, the Staff noted that issuers must disclose the “issuer estimated value” on the cover page of the offering document, and share this information with investors prior to the time of sale. This estimated value should be based on the value of the “bond” element and the “derivative” element of the offered structured note. It seems that the Staff continues to think about a structured note as a “compound” security, comprised of two components. Disclosure documents should include a description of the estimated value, and any models used in the calculation of this amount. In calculating the value of the bond component, an issuer may use its internal funding rate or prevailing spreads. In discussing the value of the derivative component that has factored into the estimated value, the issuer should discuss any valuation models or assumptions.
Structured products are essentially bundles of bonds and derivatives (mostly options).  To value a product, an analyst can value that bundle of options -- or calibrate to options traded on an exchange -- and compare it to the purchase price of the structured product.

We have valued thousands of structured products and have found that structured products are typically valued between 92 and 98 cents on the dollar, values that are also supported by the academic literature.  Issuers, of course, perform this valuation to ensure that their product can be hedged profitably in the open market.

It looks like they will now have to disclose that value, and thus that profit margin, to investors.  As pointed out by Kevin Dugan in this week's Bloomberg Structured Notes Brief, some issuers have already begun disclosing initial values on their structured products offering documents.  For example, Goldman's disclosure reads, with emphasis added:
The estimated value of your notes at the time the terms of your notes were set...was equal to approximately $965 per $1,000 face amount, which is less than the original issue price. ...the price (not including GS&Co.’s customary bid and ask spreads) at which GS&Co. would initially buy or sell notes (if it makes a market, which it is not obligated to do) and the value that GS&Co. will initially use for account statements and otherwise equals approximately $990 per $1,000 face amount, which exceeds the estimated value of your notes as determined by reference to these models.
Until this change is fully adopted, you can always find our valuations for recently issued products in our structured product database, along with other helpful analysis tools.

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