Monday, June 3, 2013

Investors Bristle at New Structured Product Valuations

By Tim Dulaney, PhD and Tim Husson, PhD

Back in February, the SEC issued a letter to structured product issuers that required them to estimate and prominently state the estimated value of the notes to investors.   According to Risk.net, as issuers have begun doing so, many investors have "expressed surprise" at how low those valuations are.

However, these valuations should be no surprise to anyone familiar with the structured product literature, which has documented significant discounts for a wide variety of product types.  You can see for example our work on reverse convertiblesabsolute return barrier notes, autocallables, and dual-directionals, as well as others on our research page.

According to the Risk article, the banks' response has been tepid:
Banks say the difference between the face amount and estimated value does not necessarily reflect profits to them. "Our valuation may be 92% or 93% of face value, but we don't value this as profit from an accounting perspective," says Samuel Rosenberg, New York-based deputy head of sales in cross-asset solutions at Société Générale... 
Bankers say the questions from investors and dealers will likely ease once the market becomes more comfortable. "It's just noise," says the New York-based banker. "My sense is that over time people probably won't pay much attention to it."
To be clear, we think investors should care about the estimated value of their products, no matter what profit the issuer books on the deal.  According to the SEC guidelines, estimated values reflect the cost of the embedded bond and derivative positions that make up the structured product.  The structured product's value to the investor is simply the sum of those positions (taking into account the credit risk of the issuer, of couse), which should be represented by the estimated value.  No matter who is booking the difference, investors should be deeply concerned about the discrepancy between the price they are charged and the value of what they are getting.

In fact, we think it is so important that we have created over 16,000 structured product reports--available free of charge--which include not only estimated values but a breakdown of the derivative and bond positions for each product.  We think the systematic over-pricing of structured products is strong evidence that such investments should not be sold to retail investors.

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