Lehman's `100% Principal Protection' Means Pennies for Notes
By Bradley Keoun
Sept. 29 (Bloomberg) -- A brochure pitching $1.84 million of notes sold by Lehman Brothers Holdings Inc. in August, a month before the firm filed for bankruptcy, promised ``100 percent principal protection.''
Buyers had ``uncapped appreciation potential'' pegged to gains in the Standard & Poor's 500 Index, the brochure said. In the worst case, they would get back their $1,000-per-note investment in three years. Only the last in a list of 15 risk factors mentioned the biggest danger:
``An investment in the notes will be subject to the credit risk of Lehman Brothers.''
Lehman's Sept. 15 bankruptcy leaves holders of the notes waiting in line with other unsecured creditors for what's left of their money. The collapse has rattled Wall Street's $114 billion structured-notes business, which Lehman, Merrill Lynch & Co., Morgan Stanley and Goldman Sachs Group Inc., all based in New York, used to raise cheaper funding as the credit crisis drove bond yields higher. About three-fifths of the $68.1 billion sold this year were bought by individual investors, according to data compiled by mtn-i, a London-based firm that tracks the market.
``Investors are going to be a lot more concerned about the credit of the issuers of these notes,'' said James Angel, an associate professor of finance at Georgetown University in Washington. Until recently, ``the buyers may have been mesmerized by the bells and the whistles,'' he said.
The market for structured notes -- constructed by Wall Street firms from a combination of bonds, stocks, commodities, currencies and derivatives -- has mostly avoided fallout from the slump in sales of mortgage-backed collateralized debt obligations and auction-market preferred securities.
For the full article from Bloomberg, click here.
SPA-2008
Monday, September 29, 2008
Monday, September 22, 2008
New Restrictions
On September 18, the SEC issued a series of emergency orders to address short sales and reporting of short positions. Click here for the full version provided by Morrison and Foerster.
Tuesday, September 16, 2008
SPA Statement on Structured Products Careers
The extraordinary events of the last several days have reshaped our industry in ways that were once unimaginable. The Structured Products Association is working to find opportunities for highly talented professionals in the US structured products industry who are being displaced in the wake of the reshaping of our business.
If you are an internal human resources professional or a recruiter with opportunities in the structured products arena -- whether in the US or not, kindly email career.opportunities@structuredproducts.org. The SPA will make the opportunities available on its website, and -- if permissible -- via email to its 8,000 members.
The SPA's October 2, 2008 AutumnExpo at New York's Grand Hyatt Hotel will also feature a panel on the reshaping of the financial services industry and how it will impact careers in structured products.
Click here for the agenda.
Click here for the form to sign up for the single-day October 2, 2008 event.
For the New York Times' blog on this post, click here.
If you are an internal human resources professional or a recruiter with opportunities in the structured products arena -- whether in the US or not, kindly email career.opportunities@structuredproducts.org. The SPA will make the opportunities available on its website, and -- if permissible -- via email to its 8,000 members.
The SPA's October 2, 2008 AutumnExpo at New York's Grand Hyatt Hotel will also feature a panel on the reshaping of the financial services industry and how it will impact careers in structured products.
Click here for the agenda.
Click here for the form to sign up for the single-day October 2, 2008 event.
For the New York Times' blog on this post, click here.
Monday, September 15, 2008
FT Analysis: A brave decision on Lehman
by Avinash Persaud
It was a brave decision. By abandoning Lehman Brothers, a 158-year-old piece of Wall Street furniture, and refusing to remove their hands from their pockets when Merrill Lynch came calling, US Treasury Secretary Hank Paulson and New York Fed Governor Tim Geithner had one of the busiest weekends of dispassion on record. There will be much fall-out in financial markets over the next few weeks and even more uncertainty.
Two questions come immediately to mind. Why give guarantees to JPMorgan to help it to buy Bear Stearns in March 2008 but decline to do so six months later for Lehman Brothers, a larger institution? Second, will Lehman’s bankruptcy make financial conditions better or worse? There is rhyme to the reasoning behind saying no to Lehman Brothers and while things will get worse over the short-term, the alternative may have been the same pain, drawn out for longer.
There were reasons for saying no to Lehman that were not there for Bear. First, there is the distinction between solvency and liquidity. The liquidity arrangements the Fed put in place after the Bear Stearns collapse means that institutions that fail now are more likely to have a solvency problem than a temporary liquidity issue. The policy mistake that contributed to a decade of missing growth in Japan in the 1990s was allowing insolvent institutions to limp along, while praying for a revival in market prices that never came.
Second, there is the issue of moral hazard. While central banks have been offering liquidity on generous terms and stopping institutions from going bankrupt, some banks were not engaged in hard restructuring, but gaming the system. They were busy hoarding liquidity and pushing risky instruments into the hands of the authorities. Why did it take the edge of bankruptcy for Lehman to draw up plans to hold $30bn of hard-to-sell commercial property assets into a separate entity? The situation was complex and changing but bankers will recognise today that the game is not about luring sovereign wealth funds to invest before markets recover, but how to restructure for a brave new world in which the financial sector is smaller.
Third, there was a new and alarming factor not present at the time of Bear that argued strongly against new government guarantees. Since the August rescue of Freddie Mac and Fannie Mae, credit markets have begun to price in the possibility of a default by the US government – the implied probability remains a fraction of 1 per cent but it is an unprecedented development.
Finally, there is the systemic risk. Bankers always argue that if they are not redeemed of their sins that hell and damnation will fall upon the rest of us. This normally works. When Bear Stearns was tottering on the edge, it was argued that as it was the leading investment bank in the mortgage business, letting it fail would spread woe from the cloisters of banking to Main Street. The mortgage market still fell apart and a large chunk of it – Freddie and Fannie – has in effect been nationalised. Officials may have felt that the failure today of Lehman, an institution not heavily involved in residential mortgage lending, was not going to make much difference.
There will be systemic fall-out from the Lehman bankruptcy, however.
For the complete analysis from FT.com, click here.
It was a brave decision. By abandoning Lehman Brothers, a 158-year-old piece of Wall Street furniture, and refusing to remove their hands from their pockets when Merrill Lynch came calling, US Treasury Secretary Hank Paulson and New York Fed Governor Tim Geithner had one of the busiest weekends of dispassion on record. There will be much fall-out in financial markets over the next few weeks and even more uncertainty.
Two questions come immediately to mind. Why give guarantees to JPMorgan to help it to buy Bear Stearns in March 2008 but decline to do so six months later for Lehman Brothers, a larger institution? Second, will Lehman’s bankruptcy make financial conditions better or worse? There is rhyme to the reasoning behind saying no to Lehman Brothers and while things will get worse over the short-term, the alternative may have been the same pain, drawn out for longer.
There were reasons for saying no to Lehman that were not there for Bear. First, there is the distinction between solvency and liquidity. The liquidity arrangements the Fed put in place after the Bear Stearns collapse means that institutions that fail now are more likely to have a solvency problem than a temporary liquidity issue. The policy mistake that contributed to a decade of missing growth in Japan in the 1990s was allowing insolvent institutions to limp along, while praying for a revival in market prices that never came.
Second, there is the issue of moral hazard. While central banks have been offering liquidity on generous terms and stopping institutions from going bankrupt, some banks were not engaged in hard restructuring, but gaming the system. They were busy hoarding liquidity and pushing risky instruments into the hands of the authorities. Why did it take the edge of bankruptcy for Lehman to draw up plans to hold $30bn of hard-to-sell commercial property assets into a separate entity? The situation was complex and changing but bankers will recognise today that the game is not about luring sovereign wealth funds to invest before markets recover, but how to restructure for a brave new world in which the financial sector is smaller.
Third, there was a new and alarming factor not present at the time of Bear that argued strongly against new government guarantees. Since the August rescue of Freddie Mac and Fannie Mae, credit markets have begun to price in the possibility of a default by the US government – the implied probability remains a fraction of 1 per cent but it is an unprecedented development.
Finally, there is the systemic risk. Bankers always argue that if they are not redeemed of their sins that hell and damnation will fall upon the rest of us. This normally works. When Bear Stearns was tottering on the edge, it was argued that as it was the leading investment bank in the mortgage business, letting it fail would spread woe from the cloisters of banking to Main Street. The mortgage market still fell apart and a large chunk of it – Freddie and Fannie – has in effect been nationalised. Officials may have felt that the failure today of Lehman, an institution not heavily involved in residential mortgage lending, was not going to make much difference.
There will be systemic fall-out from the Lehman bankruptcy, however.
For the complete analysis from FT.com, click here.
Fire Sale: Lehman Indexes Unit (IndexUniverse.com)
by Murray Coleman
Even after Lehman Brothers filed for bankruptcy protection on Sunday, the investment banks' asset management business was being shopped Monday to a host of interested parties.
Along those lines, a still-lucrative part of Lehman that could also help attract buyers is its indexing products group. The unit, which began some 35 years ago, maintains and publishes thousands of indexes that are used around the world by both active and passive money managers to track different markets.
According to Lehman's estimates, the group had a total of roughly $6.9 trillion benchmarked to those products by the end of last year.
In particular, the Lehman brand has become known for its expertise in covering fixed-income markets. It was the first to publish a total return bond index, and the Lehman Brothers Aggregate U.S. Bond index remains the de facto standard for broad indicators of fixed-income markets for advisors and managers domestically.
The indexing group is considered part of Lehman's fixed-income research unit. That's separate from the firm's asset management group and part of the broker-dealer side of the business. On Monday, The Wall Street Journal reported that several rivals could be interested in buying different parts of Lehman. Specifically, it pointed to the asset management arm. The report listed Bain Capital, Hellman & Friedman and Clayton Dubilier & Rice as possible suitors.
"Everyone uses their bond indexes. You'd have to assume that would be a pretty attractive asset to come out of bankruptcy or attract another party if Lehman decides to sell-off parts of its business," said Raymond Benton, a Denver-based advisor.
Portfolio managers at Compass Efficient Model Portfolios aren't too concerned about the fate of Lehman's indexing services, either. The Nashville, Tenn.-based money manager oversees about $3 billion in assets for advisors and institutions around the country.
"To us, having Lehman on the name of an index is similar to walking into a stadium with a company's name on the outside," said Steve Hammers, chief investment officer at Compass.
"Lehman doesn't own every bond in their indexes. So this is more of a marketing and services story than anything."
Big institutions pay Lehman to get data to put together and keep their bond indexes running, he noted. "If Standard & Poor's goes under, it's not going to impact the companies in the S&P 500," said Hammers. "It might affect the market, but Lehman's indexing group is still going to be a valuable commodity."
He points out that while stock indexes have been plummeting this year, fixed-income benchmarks tied to Lehman's most popular products have largely been in the black. "Lehman's indexing group is a long-standing name in the industry," Hammers said. "As Lehman tries to liquidate its assets, their brand is still going to be worth something."
He thinks a possible suitor might be Citigroup. "We have 2,200 indexes in our database, and they're the largest provider of fixed-income benchmarks," Hammers said. "So it would make a lot of sense for Citigroup to really take advantage of this situation."
Lehman used to be the biggest provider in fixed-income, he says. But since the early 1980s, when Citigroup started publishing its U.S. fixed-income indexes, the firm has come on strong.
"Lehman had a better-than 10 year jump on Citigroup in terms of getting into the U.S. bond indexing market," Hammers said. "But Citigroup now has 380 major U.S. fixed-income benchmarks that we're aware of through our various subscriber services. So it's fair to say that Citigroup has really built out their fixed-income indexing operation."
But he says that Lehman still has the advantage of being able to attract monster assets and fees from a smaller number of popular longstanding industry benchmarks. That gives the indexing pioneer a large asset base that could prove enticing to possible buyers.
"In sheer numbers of indexes, Citigroup actually has built a bigger presence in the bond world," Hammers said.
Credit Suisse is another major player in bond indexes that might be a possibility, he adds. So could Dow Jones, which is big in the equity world, according to Hammers.
Other notable indexing players he lists as possibilities include Merrill Lynch, which his analysts estimate has about 60 major bond benchmarks. "But I doubt they'd be interested right now. They've got too much going on right now and it would probably come down to Bank of America's decision in the end," Hammers said.
Gary Gastineau, head of ETF Consultants, notes that Lehman's index services business probably makes more sense to suitor already in the bond industry. But anyone interested in moving into the fixed-income brokering arena, he adds, might want to double-dip.
"Somebody who wanted to get into the bond industry might find Lehman's index business a nice add-on," said Gastineau. "But I don't think they'd want to do the index piece without also picking up Lehman's bond trading operation. And both are very strong parts of the existing company."
Some of the most popular bond exchange-traded funds use Lehman indexes. Those include the iShares Lehman Aggregate Bond index (NYSE: AGG) and the Vanguard Total Bond Market ETF (AMEX: VTI).
"Even if it goes to bankruptcy, Lehman doesn't hold any of the assets - iShares and other ETF providers do. So what investors need to worry about is the remote possibility that Lehman stops providing the underlying indexes," said Michael Krause, president of AltaVista Independent Reasearch in New York City.
In that case, the bond funds would simply convert to using another firm's benchmarks since plenty of competitors are waiting in the wings to snatch some of Lehman's market share, he added.
Krause doubts that's going to happen, however. "Someone will be interested in a healthy and I'm sure profitable Lehman indexing services business," he said.
For the original posting on IndexUniverse.com, click here.
Even after Lehman Brothers filed for bankruptcy protection on Sunday, the investment banks' asset management business was being shopped Monday to a host of interested parties.
Along those lines, a still-lucrative part of Lehman that could also help attract buyers is its indexing products group. The unit, which began some 35 years ago, maintains and publishes thousands of indexes that are used around the world by both active and passive money managers to track different markets.
According to Lehman's estimates, the group had a total of roughly $6.9 trillion benchmarked to those products by the end of last year.
In particular, the Lehman brand has become known for its expertise in covering fixed-income markets. It was the first to publish a total return bond index, and the Lehman Brothers Aggregate U.S. Bond index remains the de facto standard for broad indicators of fixed-income markets for advisors and managers domestically.
The indexing group is considered part of Lehman's fixed-income research unit. That's separate from the firm's asset management group and part of the broker-dealer side of the business. On Monday, The Wall Street Journal reported that several rivals could be interested in buying different parts of Lehman. Specifically, it pointed to the asset management arm. The report listed Bain Capital, Hellman & Friedman and Clayton Dubilier & Rice as possible suitors.
"Everyone uses their bond indexes. You'd have to assume that would be a pretty attractive asset to come out of bankruptcy or attract another party if Lehman decides to sell-off parts of its business," said Raymond Benton, a Denver-based advisor.
Portfolio managers at Compass Efficient Model Portfolios aren't too concerned about the fate of Lehman's indexing services, either. The Nashville, Tenn.-based money manager oversees about $3 billion in assets for advisors and institutions around the country.
"To us, having Lehman on the name of an index is similar to walking into a stadium with a company's name on the outside," said Steve Hammers, chief investment officer at Compass.
"Lehman doesn't own every bond in their indexes. So this is more of a marketing and services story than anything."
Big institutions pay Lehman to get data to put together and keep their bond indexes running, he noted. "If Standard & Poor's goes under, it's not going to impact the companies in the S&P 500," said Hammers. "It might affect the market, but Lehman's indexing group is still going to be a valuable commodity."
He points out that while stock indexes have been plummeting this year, fixed-income benchmarks tied to Lehman's most popular products have largely been in the black. "Lehman's indexing group is a long-standing name in the industry," Hammers said. "As Lehman tries to liquidate its assets, their brand is still going to be worth something."
He thinks a possible suitor might be Citigroup. "We have 2,200 indexes in our database, and they're the largest provider of fixed-income benchmarks," Hammers said. "So it would make a lot of sense for Citigroup to really take advantage of this situation."
Lehman used to be the biggest provider in fixed-income, he says. But since the early 1980s, when Citigroup started publishing its U.S. fixed-income indexes, the firm has come on strong.
"Lehman had a better-than 10 year jump on Citigroup in terms of getting into the U.S. bond indexing market," Hammers said. "But Citigroup now has 380 major U.S. fixed-income benchmarks that we're aware of through our various subscriber services. So it's fair to say that Citigroup has really built out their fixed-income indexing operation."
But he says that Lehman still has the advantage of being able to attract monster assets and fees from a smaller number of popular longstanding industry benchmarks. That gives the indexing pioneer a large asset base that could prove enticing to possible buyers.
"In sheer numbers of indexes, Citigroup actually has built a bigger presence in the bond world," Hammers said.
Credit Suisse is another major player in bond indexes that might be a possibility, he adds. So could Dow Jones, which is big in the equity world, according to Hammers.
Other notable indexing players he lists as possibilities include Merrill Lynch, which his analysts estimate has about 60 major bond benchmarks. "But I doubt they'd be interested right now. They've got too much going on right now and it would probably come down to Bank of America's decision in the end," Hammers said.
Gary Gastineau, head of ETF Consultants, notes that Lehman's index services business probably makes more sense to suitor already in the bond industry. But anyone interested in moving into the fixed-income brokering arena, he adds, might want to double-dip.
"Somebody who wanted to get into the bond industry might find Lehman's index business a nice add-on," said Gastineau. "But I don't think they'd want to do the index piece without also picking up Lehman's bond trading operation. And both are very strong parts of the existing company."
Some of the most popular bond exchange-traded funds use Lehman indexes. Those include the iShares Lehman Aggregate Bond index (NYSE: AGG) and the Vanguard Total Bond Market ETF (AMEX: VTI).
"Even if it goes to bankruptcy, Lehman doesn't hold any of the assets - iShares and other ETF providers do. So what investors need to worry about is the remote possibility that Lehman stops providing the underlying indexes," said Michael Krause, president of AltaVista Independent Reasearch in New York City.
In that case, the bond funds would simply convert to using another firm's benchmarks since plenty of competitors are waiting in the wings to snatch some of Lehman's market share, he added.
Krause doubts that's going to happen, however. "Someone will be interested in a healthy and I'm sure profitable Lehman indexing services business," he said.
For the original posting on IndexUniverse.com, click here.
Does The Lehman Filing Damage ETNs? (Index Universe)
Matthew Hougan
Kudos to Murray Coleman for his timely story last Friday on the threat posed to investors in the Lehman Brothers' Opta ETNs.
Since the first exchange-traded note launched in 2006, we've been reminding investors that ETNs are debt notes. And as debt notes, if the underwriting bank goes bankrupt, you lose out. That may happen with Lehman and its trio of Opta-branded ETNs, unless another firm steps in to make good on the promises, or the notes are otherwise excluded from the bankruptcy filing.
Remember: With an ETN, you don't own any share in physical assets. All you own is a promise from the underwriting bank. Unless the notes are somehow "made good," any investor holding a Lehman ETN today will be a creditor of the firm, just like folks holding other forms of Lehman debt. The likelihood that noteholders will receive full value for their shares in a liquidation is close to zero.
Importantly, this credit risk does not apply to exchange-traded funds at all.
An ETF is required to hold physical assets on its books, which are kept separate from the product issuer. For instance, the S&P 500 SPDR (AMEX: SPY) owns shares in each of the 500 stocks in the S&P 500 Index. If you own a share of SPY, you own a pro rata stake in each of those 500 stocks. Even if the product issuer (SSgA) went bankrupt, you would still own those shares.
That is not the case with an ETN.
That said, all the other ETN issuers appear to be in good shape on the credit front. The list of banks backing ETNs besides Lehman includes Barclays Capital, Deutsche Bank, Goldman Sachs, HSBC, Merrill Lynch (now Bank of America), Swedish Export Credit Corp. and UBS. All those banks appear to be solid right now, assuming the Merrill Lynch merger goes through.
Perhaps that's one of the reasons there were few assets in the Lehman products; people may have had those concerns already. This is a situation where investors must look at the credit issuer on an individual basis.
As Jim said, I have a bet with Don Friedman right now that the DJIA will dip below 10,000 before it rises above 15,000. We made the bet about a year ago. $100 is on the line.
I don't want to win the bet, for obvious reasons. And despite the current developments, I'm not sure I will. Things are really bad, but you get the feeling (as Jim suggests) that we're closing in on a point where there will be significant money to be made in the stock market.
Interesting times.
Kudos to Murray Coleman for his timely story last Friday on the threat posed to investors in the Lehman Brothers' Opta ETNs.
Since the first exchange-traded note launched in 2006, we've been reminding investors that ETNs are debt notes. And as debt notes, if the underwriting bank goes bankrupt, you lose out. That may happen with Lehman and its trio of Opta-branded ETNs, unless another firm steps in to make good on the promises, or the notes are otherwise excluded from the bankruptcy filing.
Remember: With an ETN, you don't own any share in physical assets. All you own is a promise from the underwriting bank. Unless the notes are somehow "made good," any investor holding a Lehman ETN today will be a creditor of the firm, just like folks holding other forms of Lehman debt. The likelihood that noteholders will receive full value for their shares in a liquidation is close to zero.
Importantly, this credit risk does not apply to exchange-traded funds at all.
An ETF is required to hold physical assets on its books, which are kept separate from the product issuer. For instance, the S&P 500 SPDR (AMEX: SPY) owns shares in each of the 500 stocks in the S&P 500 Index. If you own a share of SPY, you own a pro rata stake in each of those 500 stocks. Even if the product issuer (SSgA) went bankrupt, you would still own those shares.
That is not the case with an ETN.
That said, all the other ETN issuers appear to be in good shape on the credit front. The list of banks backing ETNs besides Lehman includes Barclays Capital, Deutsche Bank, Goldman Sachs, HSBC, Merrill Lynch (now Bank of America), Swedish Export Credit Corp. and UBS. All those banks appear to be solid right now, assuming the Merrill Lynch merger goes through.
Perhaps that's one of the reasons there were few assets in the Lehman products; people may have had those concerns already. This is a situation where investors must look at the credit issuer on an individual basis.
As Jim said, I have a bet with Don Friedman right now that the DJIA will dip below 10,000 before it rises above 15,000. We made the bet about a year ago. $100 is on the line.
I don't want to win the bet, for obvious reasons. And despite the current developments, I'm not sure I will. Things are really bad, but you get the feeling (as Jim suggests) that we're closing in on a point where there will be significant money to be made in the stock market.
Interesting times.
FALLOUT - M-Stanley, Goldman Credit Default Premiums Surge (Bloomberg)
by Abigail Moses and Bryan Keogh
Sept. 15 (Bloomberg) -- Morgan Stanley and Goldman Sachs Group Inc. led a record surge in the cost of default protection and a slump in bank bond prices after Lehman Brothers Holdings Inc. filed for bankruptcy.
Credit-default swaps on Morgan Stanley soared to a record and the New York-based firm's senior notes fell the most since they were sold six month ago. Goldman's senior notes plummeted to a record low and the cost of protecting its bonds against default rose to an all-time high.
Sellers were demanding upfront payments for protecting American International Group Inc. and Washington Mutual Inc. on rising concern that they would default.
Investor speculation that Lehman's bankruptcy may trigger further takeovers or mergers roiled credit markets after the Treasury and the Federal Reserve declined to rescue Lehman, as they did in March with Bear Stearns Cos.Merrill Lynch & Co. agreed to be bought by Bank of America Corp. as the credit crisis threatened the global financial industry.
Goldman and Morgan Stanley, the two remaining major Wall Street investment banks, ``made the same mistakes'' as Merrill and Lehman, and ``anybody in that business is at risk,'' said Gregory Habeeb, a portfolio manager at Calvert Asset Management Co. in Bethesda, Maryland.
``The dangers have intensified,'' said Habeeb, who manages $8.5 billion in fixed-income assets and doesn't own Lehman bonds. `` There was a lesson of Bear Stearns and apparently Lehman didn't learn it. The lesson at Bear Stearns and Lehman may have precipitated Merrill to do something.''
Upfront Payments
Credit-default swaps on Morgan Stanley soared 189 basis points to 453 and its senior notes now yield more than a typical bond rated BB, or seven grades lower. Contracts on Goldman jumped 119 basis points to 318 basis points. Credit default swaps on Merrill, the world's biggest brokerage firm, dropped after it agreed to the Bank of America purchase.
Increased credit-market turmoil is forcing 17 financial companies' credit-default swaps to trade upfront, meaning those seeking protection must make an initial payment as well as premiums, signaling rising default concern, according to CMA Datavision.
Sellers demanded 47 percentage points upfront and 5 percentage points a year to protect the bonds of Washington Mutual from default on concern that the biggest U.S. savings and loan won't survive the credit crisis, according to CMA Datavision prices in New York. That compares with an upfront cost of 40 percentage points on Sept. 12 and means it would cost $5 million initially and $500,000 a year to protect $10 million in bonds for five years.
AIG Bonds
The upfront cost to protect AIG bonds from default soared 16.5 percentage points to 29 percentage points after earlier rising to 34 percentage points, CMA data show. The insurer's 5.85 percent notes due in 2018 fell 14.5 cents to 55 cents on the dollar to yield 14.9 percent, according to Trace, the Financial Industry Regulatory Authority's bond-pricing service.
The U.S. government's decision not to bail out Lehman reduces the ``moral hazard'' introduced when Bear Stearns was rescued and the Bank of England nationalized mortgage lender Northern Rock Plc, according to Juan Esteban Valencia, a credit strategist at Societe Generale SA in London.
``The get-out-of-jail-free card turned out not to be worth what they thought,'' said Matt King, head of quantitative credit strategy at Citigroup Inc. in London. ``This makes it much, much harder for financial institutions to get the financing they need.''
Contracts on Wachovia Corp., the fourth-biggest U.S. bank, surged 129 basis points to 582 and JPMorgan Chase & Co. rose 42 to 185, CMA data show. Wachovia's 5.75 percent notes due in 2018 fell 3.9 percent to 73.3 cent on the dollar, while JPMorgan's 6.4 percent bonds due in 2038 trade at 92.6 cents on the dollar after losing 3.7 cents.
Merrill dropped 139 basis points to 319 basis points. Bank of America increased 53 basis points to 212.
Morgan Stanley Notes
Morgan Stanley's 6.625 percent senior unsecured notes due in 2018 fell 10.9 cents to 81.3 cents on the dollar for a yield of 9.7 percent, according to Trace. Debt rated BB on average yields 9.1 percent, according to Merrill's U.S. High-Yield BB Rated index. Morgan Stanley's notes are rated A1 by Moody's Investors Service and A+ by Standard & Poor's.
Goldman's 6.15 percent notes due in 2018 dropped 7.3 cents to 88.3 cents on the dollar to yield 7.9 percent, Trace data show. The New York-based securities firm's 6.35 percent bonds due in 2034 fell 10.6 cents to 71.7 cents on the dollar, for a yield of 9.3 percent.
In Europe, HSBC Holdings Plc, Europe's biggest bank, and Barclays Plc led a jump in the cost of default protection, driving the benchmark Markit iTraxx Financial index of 25 banks and insurers a record 32 basis points higher to 127, according to JPMorgan.
HSBC, Barclays
The Markit CDX North America Investment Grade Index, linked to the bonds of 125 companies in the U.S. and Canada, rose 38 basis points to 189 as of 2:49 p.m., according to broker Phoenix Partners Group. Earlier they traded as high as 190 basis points.
Credit-default swaps on London based HSBC soared 22 basis points to 93, the most ever, according to CMA Datavision prices in London. Barclays, the U.K.'s third-biggest bank, rose 34 to 166, Zurich-based UBS AG jumped 28 to 164 and Spain's Banco Santander surged 22 to 122.
Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline signals the opposite.
A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.
Source: Bloomberg.com.
Sept. 15 (Bloomberg) -- Morgan Stanley and Goldman Sachs Group Inc. led a record surge in the cost of default protection and a slump in bank bond prices after Lehman Brothers Holdings Inc. filed for bankruptcy.
Credit-default swaps on Morgan Stanley soared to a record and the New York-based firm's senior notes fell the most since they were sold six month ago. Goldman's senior notes plummeted to a record low and the cost of protecting its bonds against default rose to an all-time high.
Sellers were demanding upfront payments for protecting American International Group Inc. and Washington Mutual Inc. on rising concern that they would default.
Investor speculation that Lehman's bankruptcy may trigger further takeovers or mergers roiled credit markets after the Treasury and the Federal Reserve declined to rescue Lehman, as they did in March with Bear Stearns Cos.Merrill Lynch & Co. agreed to be bought by Bank of America Corp. as the credit crisis threatened the global financial industry.
Goldman and Morgan Stanley, the two remaining major Wall Street investment banks, ``made the same mistakes'' as Merrill and Lehman, and ``anybody in that business is at risk,'' said Gregory Habeeb, a portfolio manager at Calvert Asset Management Co. in Bethesda, Maryland.
``The dangers have intensified,'' said Habeeb, who manages $8.5 billion in fixed-income assets and doesn't own Lehman bonds. `` There was a lesson of Bear Stearns and apparently Lehman didn't learn it. The lesson at Bear Stearns and Lehman may have precipitated Merrill to do something.''
Upfront Payments
Credit-default swaps on Morgan Stanley soared 189 basis points to 453 and its senior notes now yield more than a typical bond rated BB, or seven grades lower. Contracts on Goldman jumped 119 basis points to 318 basis points. Credit default swaps on Merrill, the world's biggest brokerage firm, dropped after it agreed to the Bank of America purchase.
Increased credit-market turmoil is forcing 17 financial companies' credit-default swaps to trade upfront, meaning those seeking protection must make an initial payment as well as premiums, signaling rising default concern, according to CMA Datavision.
Sellers demanded 47 percentage points upfront and 5 percentage points a year to protect the bonds of Washington Mutual from default on concern that the biggest U.S. savings and loan won't survive the credit crisis, according to CMA Datavision prices in New York. That compares with an upfront cost of 40 percentage points on Sept. 12 and means it would cost $5 million initially and $500,000 a year to protect $10 million in bonds for five years.
AIG Bonds
The upfront cost to protect AIG bonds from default soared 16.5 percentage points to 29 percentage points after earlier rising to 34 percentage points, CMA data show. The insurer's 5.85 percent notes due in 2018 fell 14.5 cents to 55 cents on the dollar to yield 14.9 percent, according to Trace, the Financial Industry Regulatory Authority's bond-pricing service.
The U.S. government's decision not to bail out Lehman reduces the ``moral hazard'' introduced when Bear Stearns was rescued and the Bank of England nationalized mortgage lender Northern Rock Plc, according to Juan Esteban Valencia, a credit strategist at Societe Generale SA in London.
``The get-out-of-jail-free card turned out not to be worth what they thought,'' said Matt King, head of quantitative credit strategy at Citigroup Inc. in London. ``This makes it much, much harder for financial institutions to get the financing they need.''
Contracts on Wachovia Corp., the fourth-biggest U.S. bank, surged 129 basis points to 582 and JPMorgan Chase & Co. rose 42 to 185, CMA data show. Wachovia's 5.75 percent notes due in 2018 fell 3.9 percent to 73.3 cent on the dollar, while JPMorgan's 6.4 percent bonds due in 2038 trade at 92.6 cents on the dollar after losing 3.7 cents.
Merrill dropped 139 basis points to 319 basis points. Bank of America increased 53 basis points to 212.
Morgan Stanley Notes
Morgan Stanley's 6.625 percent senior unsecured notes due in 2018 fell 10.9 cents to 81.3 cents on the dollar for a yield of 9.7 percent, according to Trace. Debt rated BB on average yields 9.1 percent, according to Merrill's U.S. High-Yield BB Rated index. Morgan Stanley's notes are rated A1 by Moody's Investors Service and A+ by Standard & Poor's.
Goldman's 6.15 percent notes due in 2018 dropped 7.3 cents to 88.3 cents on the dollar to yield 7.9 percent, Trace data show. The New York-based securities firm's 6.35 percent bonds due in 2034 fell 10.6 cents to 71.7 cents on the dollar, for a yield of 9.3 percent.
In Europe, HSBC Holdings Plc, Europe's biggest bank, and Barclays Plc led a jump in the cost of default protection, driving the benchmark Markit iTraxx Financial index of 25 banks and insurers a record 32 basis points higher to 127, according to JPMorgan.
HSBC, Barclays
The Markit CDX North America Investment Grade Index, linked to the bonds of 125 companies in the U.S. and Canada, rose 38 basis points to 189 as of 2:49 p.m., according to broker Phoenix Partners Group. Earlier they traded as high as 190 basis points.
Credit-default swaps on London based HSBC soared 22 basis points to 93, the most ever, according to CMA Datavision prices in London. Barclays, the U.K.'s third-biggest bank, rose 34 to 166, Zurich-based UBS AG jumped 28 to 164 and Spain's Banco Santander surged 22 to 122.
Credit-default swaps, contracts conceived to protect bondholders against default, pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. A rise indicates deterioration in the perception of credit quality; a decline signals the opposite.
A basis point on a credit-default swap contract protecting $10 million of debt from default for five years is equivalent to $1,000 a year.
Source: Bloomberg.com.
UK: IFAs fear losses on Lehman structured products (MoneyMarketing.co.uk)
by Hannah Stodell
IFAs are bracing themselves for potential losses on clients' capital invested in structured products underwriitten or powered by the bankrupted investment bank Lehman Brothers.
Lowes Financial Management managing director Ian Lowes currently has 32 clients with exposure to Lehman contracts and says it is too early to gauge the final outcome of the bank’s collapse on their investments. He says: “Communications from Lehman on Friday said the proposed sale of the investment arm wouldn’t affect the structured products division. They can sell it as much as they like but something’s going to be affected. “
Meteor Asset Management has confirmed it has invested in securities issued by various Lehman Brothers subsidiaries.
Money Marketing understands that NDF also had exposure to Lehman contracts as recently as two months ago and calls to the consumer line of Isa/plan manager DRL were answered by a Lehman Brothers answer phone message.
At this stage Meteor says it does not know how the Chapter 11 filing in respect of the holding company will affect these products. It says: “At present, we understand that all other Lehman companies are still trading, and it appears likely that it is intended to undertake an orderly liquidation of the group, selling off each business unit. We have been in contact with Lehman Brothers in London this morning, but as yet they can give us very little information.”
Source: MoneyMarketing.co.uk.
IFAs are bracing themselves for potential losses on clients' capital invested in structured products underwriitten or powered by the bankrupted investment bank Lehman Brothers.
Lowes Financial Management managing director Ian Lowes currently has 32 clients with exposure to Lehman contracts and says it is too early to gauge the final outcome of the bank’s collapse on their investments. He says: “Communications from Lehman on Friday said the proposed sale of the investment arm wouldn’t affect the structured products division. They can sell it as much as they like but something’s going to be affected. “
Meteor Asset Management has confirmed it has invested in securities issued by various Lehman Brothers subsidiaries.
Money Marketing understands that NDF also had exposure to Lehman contracts as recently as two months ago and calls to the consumer line of Isa/plan manager DRL were answered by a Lehman Brothers answer phone message.
At this stage Meteor says it does not know how the Chapter 11 filing in respect of the holding company will affect these products. It says: “At present, we understand that all other Lehman companies are still trading, and it appears likely that it is intended to undertake an orderly liquidation of the group, selling off each business unit. We have been in contact with Lehman Brothers in London this morning, but as yet they can give us very little information.”
Source: MoneyMarketing.co.uk.
BLACK SUNDAY: Lehman Files For Bankruptcy; BofA To Buy Merrill (Dow Jones)
AT A GLANCE, the events of yesterday:
THE EVENTS: Two of Wall Streets' venerable investment giants have been brought to their knees - and an insurance powerhouse hangs by its fingertips. Lehman Brothers Holdings Inc. (LEH) filed for bankruptcy protection, while Merrill Lynch (MER) agreed to be acquired by Bank of America Corp. (BAC) for $50 billion.
Meanwhile, another victim of the ongoing credit and housing crunch, insurance giant American International Group Inc. (AIG), is desperately trying to raise capital.
MARKET REACTION:
Merrill shares gained 14% to $19.51 as investors expressed relief, but Bank of America fell 18% to $27.65. Lehman stock fell 95% to 19 cents a share and AIG dropped 53% to $5.67.
The Dow Jones Industrial Average was down 279 points at 11142, Nasdaq was off 45 at 2216 and the S&P 500 fell 32 at 1219.
Treasurys soared as investors scrambled for safety.
The U.S. dollar was flat against the euro.
Oil futures slid to a seven-month low as speculators fled for perceived safe havens amid turmoil on Wall Street.
LEHMAN BROTHERS SEEKS PROTECTION:
Wracked by massive real-estate-related losses, Lehman Brothers Monday filed for Chapter 11 protection after a feverish weekend of negotiations failed to snag a potential buyer. The two most likely suitors, BofA and Barclays PLC (BCS), walked away after the U.S. government said it would not backstop Lehman's troubled assets to facilitate a sale.
Federal regulators assured Lehman brokerage customers that their accounts will be protected and transferred to other brokerage firms.
Lehman continues to seek buyers for some assets, including its U.S. broker- dealer business and its investment management arm, The Wall Street Journal reported. Barclays remains interested in buying the U.S. broker-dealer unit. Lehman is moving to sell its investment-management division as soon as this week, possibly to Bain Capital LLC, Hellman & Friedman LLC or Clayton Dubilier & Rice Inc.
MERRILL ABSORBED AMID CRISIS:
Merrill, in a rushed bid to ride out the storm sweeping Wall Street, agreed to be taken over by BofA in a $50 billion all-stock transaction. Through the weekend, federal officials strongly encouraged the deal, fearing Merrill would be the next financial house to approach the brink after Lehman.
Bank of America Chief Executive Ken Lewis said he felt "no pressure" from federal government regulators to acquire Merrill.
AIG SEEKS CAPITAL:
AIG - hobbled by credit default swap investments that have gone sour - spent the weekend trying to raise $40 billion to avoid a credit downgrade which would let counterparties pull their capital from deals with the firm. AIG Chief Executive Robert Willumstad made an extraordinary appeal to the Fed for temporary funding to tide it through the crisis.
AIG received permission from the governor of New York to access as much as $20 billion in capital from its subsidiaries to cover operating needs.
WALL STREET CIRCLES THE WAGONS:
Ten major commercial and investment banks announced Sunday they would pool $70 billion of their own money to create a borrowing facility that they could tap into to help them ride out the crisis.
U.S. TAKES STEPS TO SUPPORT FINANCIAL MARKETS:
U.S. regulators Sunday announced a series of steps - including an expansion of the Federal Reserve's credit facilities - in hopes of stabilizing financial markets after a tumultuous weekend. The moves are designed to make it easier for banks to gain access to emergency credit.
WHAT THEY SAID:
U.S. Treasury Secretary Henry Paulson said he "never once" considered using taxpayer money to bail out Lehman. "It's important that regulators remain very vigilant, we're very vigilant," he said. "But we do not take lightly ever putting the taxpayers...on the line to support an institution."
"In the long run, I'm confident that our capital markets are flexible and resilient to deal with these adjustments," said U.S. President George W. Bush.
Source: Money.CNN.com.
THE EVENTS: Two of Wall Streets' venerable investment giants have been brought to their knees - and an insurance powerhouse hangs by its fingertips. Lehman Brothers Holdings Inc. (LEH) filed for bankruptcy protection, while Merrill Lynch (MER) agreed to be acquired by Bank of America Corp. (BAC) for $50 billion.
Meanwhile, another victim of the ongoing credit and housing crunch, insurance giant American International Group Inc. (AIG), is desperately trying to raise capital.
MARKET REACTION:
Merrill shares gained 14% to $19.51 as investors expressed relief, but Bank of America fell 18% to $27.65. Lehman stock fell 95% to 19 cents a share and AIG dropped 53% to $5.67.
The Dow Jones Industrial Average was down 279 points at 11142, Nasdaq was off 45 at 2216 and the S&P 500 fell 32 at 1219.
Treasurys soared as investors scrambled for safety.
The U.S. dollar was flat against the euro.
Oil futures slid to a seven-month low as speculators fled for perceived safe havens amid turmoil on Wall Street.
LEHMAN BROTHERS SEEKS PROTECTION:
Wracked by massive real-estate-related losses, Lehman Brothers Monday filed for Chapter 11 protection after a feverish weekend of negotiations failed to snag a potential buyer. The two most likely suitors, BofA and Barclays PLC (BCS), walked away after the U.S. government said it would not backstop Lehman's troubled assets to facilitate a sale.
Federal regulators assured Lehman brokerage customers that their accounts will be protected and transferred to other brokerage firms.
Lehman continues to seek buyers for some assets, including its U.S. broker- dealer business and its investment management arm, The Wall Street Journal reported. Barclays remains interested in buying the U.S. broker-dealer unit. Lehman is moving to sell its investment-management division as soon as this week, possibly to Bain Capital LLC, Hellman & Friedman LLC or Clayton Dubilier & Rice Inc.
MERRILL ABSORBED AMID CRISIS:
Merrill, in a rushed bid to ride out the storm sweeping Wall Street, agreed to be taken over by BofA in a $50 billion all-stock transaction. Through the weekend, federal officials strongly encouraged the deal, fearing Merrill would be the next financial house to approach the brink after Lehman.
Bank of America Chief Executive Ken Lewis said he felt "no pressure" from federal government regulators to acquire Merrill.
AIG SEEKS CAPITAL:
AIG - hobbled by credit default swap investments that have gone sour - spent the weekend trying to raise $40 billion to avoid a credit downgrade which would let counterparties pull their capital from deals with the firm. AIG Chief Executive Robert Willumstad made an extraordinary appeal to the Fed for temporary funding to tide it through the crisis.
AIG received permission from the governor of New York to access as much as $20 billion in capital from its subsidiaries to cover operating needs.
WALL STREET CIRCLES THE WAGONS:
Ten major commercial and investment banks announced Sunday they would pool $70 billion of their own money to create a borrowing facility that they could tap into to help them ride out the crisis.
U.S. TAKES STEPS TO SUPPORT FINANCIAL MARKETS:
U.S. regulators Sunday announced a series of steps - including an expansion of the Federal Reserve's credit facilities - in hopes of stabilizing financial markets after a tumultuous weekend. The moves are designed to make it easier for banks to gain access to emergency credit.
WHAT THEY SAID:
U.S. Treasury Secretary Henry Paulson said he "never once" considered using taxpayer money to bail out Lehman. "It's important that regulators remain very vigilant, we're very vigilant," he said. "But we do not take lightly ever putting the taxpayers...on the line to support an institution."
"In the long run, I'm confident that our capital markets are flexible and resilient to deal with these adjustments," said U.S. President George W. Bush.
Source: Money.CNN.com.
UK Food Fight: SP Provider Slams IMA (fundstrategy.co.uk)
by Tomas Hirst
FundStrategy.com
A structured product provider has called the Investment Management Association's (IMA) warning on the use of such products "thinly veiled provocation".
This follows suggestions the IMA's warning ignores the fact almost 10% of funds in its sectors use structured products in their portfolios.
Last week the IMA sent out a press release entitled "Structured Products - Not To Be Taken At Face Value" which states that disclosure practices for the performance of structured products make them risky investments.
The release compared the performance of National Savings & Investment guaranteed equity bond (GEB) issues with the performance of the FTSE 100 index, finding that on average GEBs underperformed the index by 4.5% annually.
Chris Taylor, the chief executive of Blue Sky Asset Management, a boutique investment firm that specialises in structured investments, says to extrapolate an analysis of GEBs to the whole structured investment universe is unhelpful.
"We view it as both simplistic but also as thinly veiled provocation and we can't see the value of the information provided," he says. "If the IMA only analyses savings and investment products they are not qualified to comment on other products."
For the original article from FundStrategy.co.uk, click here.
FundStrategy.com
A structured product provider has called the Investment Management Association's (IMA) warning on the use of such products "thinly veiled provocation".
This follows suggestions the IMA's warning ignores the fact almost 10% of funds in its sectors use structured products in their portfolios.
Last week the IMA sent out a press release entitled "Structured Products - Not To Be Taken At Face Value" which states that disclosure practices for the performance of structured products make them risky investments.
The release compared the performance of National Savings & Investment guaranteed equity bond (GEB) issues with the performance of the FTSE 100 index, finding that on average GEBs underperformed the index by 4.5% annually.
Chris Taylor, the chief executive of Blue Sky Asset Management, a boutique investment firm that specialises in structured investments, says to extrapolate an analysis of GEBs to the whole structured investment universe is unhelpful.
"We view it as both simplistic but also as thinly veiled provocation and we can't see the value of the information provided," he says. "If the IMA only analyses savings and investment products they are not qualified to comment on other products."
For the original article from FundStrategy.co.uk, click here.
WSJ Opinion: LEH, MER Wall Street Reckoning
The only thing anyone knows for certain is that today will be tumultuous for financial markets, after a historic Sunday that has remade Wall Street. With Lehman Brothers probably on the road to liquidation, and Merrill Lynch to be acquired by Bank of America, we are getting a Category 5 test of our financial levees.
In the event of a Lehman bankruptcy, we will also get a test of whether a major broker-dealer can fail without triggering a systemic crisis. As of last evening, the Federal Reserve and Treasury had refused to offer the same taxpayer guarantees to Lehman paper that it had for Bear Stearns last March. That was enough to cause Barclays and other potential Lehman acquirers to walk away.
The result will be a very rough Monday, but the government had to draw a line somewhere or it would have become the financier of first resort for every company hoping to buy a troubled firm. Especially with the Fed discount window now wide open to many more financial institutions, and to many kinds of collateral, Treasury Secretary Hank Paulson's refusal to blink won't get any second guessing from us. If Lehman is able to liquidate without a panic, and especially if its derivative contracts can be safely undone, the benefits would include the reassertion of "moral hazard" on Wall Street. The Merrill acquisition before it faces a Lehman-like run should also reduce the risk of contagion.
In the days ahead, Treasury will have to take more aggressive steps to protect the banking system -- including, perhaps, another Resolution Trust Corp. that can acquire real-estate and mortgage assets when there are no other buyers, provide some floor under prices, and liquidate or sell them in more orderly fashion. Whatever happens today, we'd rather not repeat the exercise.
Click here for the WSJ online version of this editorial.
In the event of a Lehman bankruptcy, we will also get a test of whether a major broker-dealer can fail without triggering a systemic crisis. As of last evening, the Federal Reserve and Treasury had refused to offer the same taxpayer guarantees to Lehman paper that it had for Bear Stearns last March. That was enough to cause Barclays and other potential Lehman acquirers to walk away.
The result will be a very rough Monday, but the government had to draw a line somewhere or it would have become the financier of first resort for every company hoping to buy a troubled firm. Especially with the Fed discount window now wide open to many more financial institutions, and to many kinds of collateral, Treasury Secretary Hank Paulson's refusal to blink won't get any second guessing from us. If Lehman is able to liquidate without a panic, and especially if its derivative contracts can be safely undone, the benefits would include the reassertion of "moral hazard" on Wall Street. The Merrill acquisition before it faces a Lehman-like run should also reduce the risk of contagion.
In the days ahead, Treasury will have to take more aggressive steps to protect the banking system -- including, perhaps, another Resolution Trust Corp. that can acquire real-estate and mortgage assets when there are no other buyers, provide some floor under prices, and liquidate or sell them in more orderly fashion. Whatever happens today, we'd rather not repeat the exercise.
Click here for the WSJ online version of this editorial.
Tuesday, September 9, 2008
FTAdviser.com (UK): SPs an Easy Adviser Sale?
by Sharon Flaherty
FTAdviser.com
There’s never a dull day (well not too many anyway) working in the financial services industry and here's a fine example.
Structured products, seemingly simple and boring on the outside, suddenly became rather interesting after the Investment Management Association (IMA) threw its two pennies worth into the ring.
In a statement to journalists across the industry, Richard Saunders, chief executive of IMA, warned against structured products because of their lack of transparency.
Source: FTAdviser.com
He said promotional literature on the products should not be taken at face value because promoters are under no obligation to report performance, making it hard to assess the accuracy of claims about product returns.
His comments, however, promoted a storm of both opposition and support.
FTAdviser.com
There’s never a dull day (well not too many anyway) working in the financial services industry and here's a fine example.
Structured products, seemingly simple and boring on the outside, suddenly became rather interesting after the Investment Management Association (IMA) threw its two pennies worth into the ring.
In a statement to journalists across the industry, Richard Saunders, chief executive of IMA, warned against structured products because of their lack of transparency.
Source: FTAdviser.com
He said promotional literature on the products should not be taken at face value because promoters are under no obligation to report performance, making it hard to assess the accuracy of claims about product returns.
His comments, however, promoted a storm of both opposition and support.
Structured Products 101: Frequently-Asked Questions
by the Structured Products Association
How do structured products work?
A structured product can come in any one of several forms -- notes, units, shares, CD or trusts. Structured products typically provide exposure to an asset class with some additional feature that is desirable to an investor (and for which the investor is willing to pay a modest premium). These features include principal protection, moderate leverage, above-market yields, alternative investment exposure or tax advantaged returns.
If there's a "derivative" embedded in the investment, what are my risks?
All structured products have a derivative element , which provides the additional feature desired by the investor. Although many advisors generally have a negative reaction to an investment with an embedded "derivative," it should be noted that the derivative exposure often takes away risk from an investment (for example, principal protection). Indeed, many vanilla securities have "embedded derivatives" such as callable bonds and convertible securities. The most prominent risk of a derivative-added investment is a misunderstanding of how the ultimate payout formula on the structured product works.
What are the fees?
Predictably, the fees vary considerably, based on the term of the investment, the reference asset and the complexity of the structured product. A recent survey by the SPA demonstrated that most structured products charge between 25 to 50 basis points per annum, considerably lower than the 1.26% fees charged by mutual funds. This figure does not take into account the cost of distribution -- or the fee charged by the broker-dealer or investment advisor.
What are the investment minimums?
Many structured products are listed on exchanges, and on the initial offering can be as low as $10 per unit. A round lot of a structured investment (100 shares) would cost an investor $1,000 plus commissions. The trend over the last five years has been to reduce the minimums for the more vanilla structured investments for retail investors to smaller sizes, in part to reduce "concentration risk" and permit diversification of issuers.
Are the investments liquid or are investors locked in for long periods?
With over 60 issuers of structured investments, competition has compelled all firms to provide at least daily liquidity for their offerings. The top structured products distribution firms such as Advisors Asset Management and Incapital will not permit access to their platforms unless the issuers meet their high standards of liquidity-on-demand. Exchange-listed securities have 15 second pricing and instant liquidity. Investors are generally not locked in, however, because of the potential complexity of some structured investments, it is important to emphasize that these are buy-and-hold securities. The benefit of a particular structured product typically comes at maturity. Such is the case with a principal protected note where the protection is guaranteed only upon maturity.
Isn't this kind of like Las Vegas? When I lose, the house wins?
Contrary to the belief of even some of the more sophisticated brokers and advisors, structured investments are not a "zero-sum game" where the issuer wins only if the investor loses. The structured products industry is very keen to create products that will have superior risk-adjusted returns that outperform other investments; the growth of the market is highly attributable to the positive returns experienced by structured products investors. The majority of growth in the $120 billion-a-year structured products business comes from repeat investors.
If structured products are so great, why doesn't everyone have them in their portfolio?
Structured products have traditionally been available only to wealthy investors of private banks. After the dot-com market decline, many investors came to learn that structured products could repair portfolios, protect capital and enhance yield. Many of these investment strategies were then made available to retail investors beginning around 2003. Much like the ETF market, it takes awhile for a revolutionary idea to go mainstream. That said, MIT Professor Zvi Bodie sees the structured products market as a $1 trillion industry in the next several years, primarily because of its applicability to boomer wealth.
Don't I have credit risk with the firm issuing the product?
Generally speaking, yes. Much like any corporate bond, the return of the security is dependent upon the creditworthiness of the issuer. This time last year it was unthinkable that a structured products issuer with the global footprint of a Bear Stearns would experience a flash-bankruptcy over the course of a single week. (Of course, structured products had nothing to do with Bear Stearns' deteriorating balance sheet, which was actually occasioned by a toxic mix of leverage and subprime mortgage-linked investments.)
What happened to the holders of Bear Stearns structured products?
Happily, holders of Bear Stearns ETNs, structured products and corporate debt are better off now than they may have been previously. Ironically, the federal government now stands behind Bear Stearns credit, meaning its outstanding debt has the explicit backing of the US Treasury. But investors would be wise to not rely on Uncle Sam in case other financial firms falter. Many investors are purchasing structured product-linked CDs in amounts under $100,000 to take advantage of FDIC insurance.
How do structured products work?
A structured product can come in any one of several forms -- notes, units, shares, CD or trusts. Structured products typically provide exposure to an asset class with some additional feature that is desirable to an investor (and for which the investor is willing to pay a modest premium). These features include principal protection, moderate leverage, above-market yields, alternative investment exposure or tax advantaged returns.
If there's a "derivative" embedded in the investment, what are my risks?
All structured products have a derivative element , which provides the additional feature desired by the investor. Although many advisors generally have a negative reaction to an investment with an embedded "derivative," it should be noted that the derivative exposure often takes away risk from an investment (for example, principal protection). Indeed, many vanilla securities have "embedded derivatives" such as callable bonds and convertible securities. The most prominent risk of a derivative-added investment is a misunderstanding of how the ultimate payout formula on the structured product works.
What are the fees?
Predictably, the fees vary considerably, based on the term of the investment, the reference asset and the complexity of the structured product. A recent survey by the SPA demonstrated that most structured products charge between 25 to 50 basis points per annum, considerably lower than the 1.26% fees charged by mutual funds. This figure does not take into account the cost of distribution -- or the fee charged by the broker-dealer or investment advisor.
What are the investment minimums?
Many structured products are listed on exchanges, and on the initial offering can be as low as $10 per unit. A round lot of a structured investment (100 shares) would cost an investor $1,000 plus commissions. The trend over the last five years has been to reduce the minimums for the more vanilla structured investments for retail investors to smaller sizes, in part to reduce "concentration risk" and permit diversification of issuers.
Are the investments liquid or are investors locked in for long periods?
With over 60 issuers of structured investments, competition has compelled all firms to provide at least daily liquidity for their offerings. The top structured products distribution firms such as Advisors Asset Management and Incapital will not permit access to their platforms unless the issuers meet their high standards of liquidity-on-demand. Exchange-listed securities have 15 second pricing and instant liquidity. Investors are generally not locked in, however, because of the potential complexity of some structured investments, it is important to emphasize that these are buy-and-hold securities. The benefit of a particular structured product typically comes at maturity. Such is the case with a principal protected note where the protection is guaranteed only upon maturity.
Isn't this kind of like Las Vegas? When I lose, the house wins?
Contrary to the belief of even some of the more sophisticated brokers and advisors, structured investments are not a "zero-sum game" where the issuer wins only if the investor loses. The structured products industry is very keen to create products that will have superior risk-adjusted returns that outperform other investments; the growth of the market is highly attributable to the positive returns experienced by structured products investors. The majority of growth in the $120 billion-a-year structured products business comes from repeat investors.
If structured products are so great, why doesn't everyone have them in their portfolio?
Structured products have traditionally been available only to wealthy investors of private banks. After the dot-com market decline, many investors came to learn that structured products could repair portfolios, protect capital and enhance yield. Many of these investment strategies were then made available to retail investors beginning around 2003. Much like the ETF market, it takes awhile for a revolutionary idea to go mainstream. That said, MIT Professor Zvi Bodie sees the structured products market as a $1 trillion industry in the next several years, primarily because of its applicability to boomer wealth.
Don't I have credit risk with the firm issuing the product?
Generally speaking, yes. Much like any corporate bond, the return of the security is dependent upon the creditworthiness of the issuer. This time last year it was unthinkable that a structured products issuer with the global footprint of a Bear Stearns would experience a flash-bankruptcy over the course of a single week. (Of course, structured products had nothing to do with Bear Stearns' deteriorating balance sheet, which was actually occasioned by a toxic mix of leverage and subprime mortgage-linked investments.)
What happened to the holders of Bear Stearns structured products?
Happily, holders of Bear Stearns ETNs, structured products and corporate debt are better off now than they may have been previously. Ironically, the federal government now stands behind Bear Stearns credit, meaning its outstanding debt has the explicit backing of the US Treasury. But investors would be wise to not rely on Uncle Sam in case other financial firms falter. Many investors are purchasing structured product-linked CDs in amounts under $100,000 to take advantage of FDIC insurance.
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