August Structured Notes: Relative Value Comparison Of 120 To-Be-Issued Structured Products

by: Reid Guenther


Presentation of estimated issuer pricings, historical and scenario valuations of 120 US structured notes to be issued in the next few weeks.

Results show that many are above fair market value, but those values depend upon the expected performance of the underliers.

Link to obtain csv files containing the data used in the tables provided at the end of the article.

Please pardon the extended absence of my structured product articles. However, given the results described below, and a now feasible plan to produce similar reports on a monthly basis, I think you may agree my time away was well spent.

120 Products Have Been Valued

These were the majority of the structured notes registered with the SEC over the last week of July and first week of August that are to be issued in the latter half of August and the beginning of September. 78 of the given products provide a growth opportunity under various performance criteria of each product's underliers; the other 42 pay regular income in the form of the periodic coupons payments also subject to underlier performance. One product (CUSIP: 17324CA55) may be claimed as both growth and income, but it has been placed in the growth category as its annual coupon payment (0.3%) is quite small relative to the other income-generating products.

Along with a surfeit of related information, individual product estimated issuer pricings, historical and scenario valuations are given in growth and income tables. The first covers the 78 growth products while the second is for the 42 income products. Before delving into the valuations, a discussion of the relevant structure information given in the tables is needed.

The first column uniquely identifies each product through its CUSIP which can be used to find each product's prospectus on the SEC's Edgar search engine here. The second column is the trade date which is the day when the initial values for each product's underliers are set. Generally speaking, it is also the last day upon which a product can be purchased. Skipping the payment feature column for now, the last three are fairly self-explanatory with the maximum term in years and the underliers given by their Bloomberg ticker symbols. Also of note, products from 13 issuers are represented in this set of valuations.

Now back to the payment features. Please forgive the author for adopting his own short hand notation, but this seemed the only sensible option given that even among an issuer's products, there are often different names for the same feature.

Description of payment feature notation:

ac: autocallable; product is automatically called if certain underlier performance criteria are met on the first of a given set of review dates. Initial principal is returned and any coupon payments or performance-dependent returns due are also paid.
buf: buffered; an added amount to the product's return of principal payment when a loss of principal occurs due to a stipulated underlier performance criteria not being met.
bskt: basket; product performance depends upon the weighted sum of a set of underlier returns.
call: callable; at set dates, the product may be called by the issuer. Initial principal is returned and any coupon payments due are also paid.
cap: capped; the product has a set maximum relative payout.
cliq: cliquet; product performance depends upon intermediate returns, with the relative performance criteria being reset at a given set of intervals.
cntCpn: contingent coupon; the amount of a coupon paid on a given payment date depends upon the performance of the underlier(s).
cpnDC: coupon daily close; product pays contingent coupons that depend on the daily closing performance of the underlier(s).
digRtn: digital return; in addition to the initial principal, the product pays a set amount as long as certain performance criteria are met by the underlier(s).
dual: dual direction; in addition to paying a return above the initial principal repayment for positive underlier performance, the product can also pays a positive return dependent upon the negative return of the underlier down to a set amount.
finDC: final daily close; final payment depends on daily closing prices over the life of the product.
fix2CntCpn: fixed to contingent coupon; coupon payments are fixed during an initial period but switch to contingent coupons afterwards.
lvg: leveraged; the returns of the product are a multiple of the underlier's positive performance.
minPerf: minimum performance; payments depend on the minimum return among a set of underliers.
minRtn: minimum return; a set floor return depending upon underlier performance(s).
prnRtn: principal return; returns the initial principal under certain negative underlier return criteria.
rngAcr: range accrual; variable coupon payments which accrue for every day the underlier is above a given level during a specified period.
stepRtn: step return; a growth feature of autocalls and callables where the maximum payable amount increases over the life of the product.

In addition to the given structure features, the tables below detail the estimated issuer pricings along with historical and scenario valuations. The historical valuations entailed calculating the average product performance over a set of historical start dates, while the scenario valuations used Monte Carlo simulation of the underliers to generate a large set of possible payoffs. The scenario valuations were calculated by taking the average of those possible payoffs. The underlier returns and volatilities used in these scenario simulations were based upon historical averages.

A term structure of discount rates specific to each product was calculated based upon the Capital Asset Pricing Model. This allows historical and scenario valuations to be an estimate of each product's risk versus reward performance relative to the market. Thus, a value of 100% represents a fair value in terms of how risky the product is in relation to how much the product pays. A value over 100% indicates the product is a better investment than simply investing in the market while the reverse is true for values less than 100%.

The listed order of the products is in descending order of their scenario valuations. This ranking criteria has been used as opposed to ranking historical valuations, as it is felt that issuers will tend to weed out products with historically poor performance.

Growth Valuations

Now, examine the growth product table. The scenario valuations range from 108% down to almost 71%. As you can see, over a third of the products (27) are estimated to have above-fair-market value. While most of the below-fair-market valuations are above 90%, there are a few quite a bit lower. Looking at the underliers indicates why these products would be expected to underperform the market as their underliers are the Euro Stoxx 50 (SX5E), the Nikkei 225 (N225) and an emerging markets ETF (NYSEARCA:EEM). This emphasizes the logical notion that the most important determination of how well a product performs depends on the underliers.

But this is not the sole determining factor of whether a product is good or not. As you can see there is a Euro Stoxx 50-based product with near fair-market value. This leads to the next point that though many products have similar payment features and the same underlier(s), their valuations can be quite different. For example, look at the buffered digital return products with an SPX undelier (CUSIPs 22548QD93 and 06741V6Y3). The adage, "the devil is in the details," comes to mind.

The importance of focusing on the details when deciding whether to purchase one of these products is apparent when you look at the historical performance of products with the lowest scenario valuation (CUSIP: 06367TJB7) shown in the graph below.

As you can see, the prevalence of drops in value of the Euro Stoxx 50 six years from each historical analysis date leads to this product having such a poor historical performance. Given that the historical return and volatility are used in simulating the underlier in the scenario valuations, you should then expect that these valuations would also have o be well below fair-market value. This leads to the point that if you believe a product's underliers will outperform its past history, then you can expect the product's returns to be higher than those shown here.

Income Valuations

Now examine the income products table. You see that the range of values are more evenly distributed with 40% of the products having scenario valuations above fair-market value. The main reason for this is that most of these structures have an autocall or call feature. These generally occur during bull markets and can actually prevent possible product losses due to subsequent market corrections. The other major factor affecting product values is the underliers. As with the growth products, a number of the income products with a Euro Stoxx 50 underlier are at the bottom of the scenario valuations. And at the top, products with the XBI, which had a nice run up through mid-2015, have valuations well above fair.

Focusing on one of the higher performing products (CUSIP: 22548QDF9), the historical performance graph below shows that the mostly positive performance from each start date over the 3-year maximum lifetime of the product, along with a fairly high contingent coupon rate of 11% annually, leads to a historical valuation well above fair-market value. And given that the historical underlier returns and volatilities are used to project the expected averages used in the scenario simulations, the scenario valuation is also well above fair-market value. Of course, as was the case for the growth product discussed, if you expect that either the XBI or the SPX will underperform their historical averages over the maximum term of the product, then the realized return of this product would not be so good.
In Conclusion

The main thrust of this article has been the presentation of 120 structured notes available for purchase before the end of August. As discussed, the valuations show that there are a good number with scenario valuations above market value. However, it must be noted that these are only expectations and the decision whether to invest in a given product should take into consideration how one thinks the product's underliers will perform over the lifetime of the product.

Finally a couple of parting notes: If you wish to ensure you do not miss future structured note valuations and analyses, please click on the follow button above. And as promised, here is the page containing links to csv files of the data presented in the tables.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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