Structured product analysis gets trickier as markets swing, CDS spreads get closer look, analyst says

By Kenneth Lim

Boston, Sept. 19 - Analyzing structured products has gotten a little tougher over the past week amid wild market movements, analyst Tim Mortimer of Future Value Consultants said.

"It definitely gets harder," Mortimer said. "Things are changing throughout the day."

Future Value factors in the issuer's credit quality in several aspects of its product ratings, Mortimer said.

The issuer's credit rating is a key component of the firm's value rating, which reflects Future Value's assessment of the total costs taken out of a product from direct fees and profit margin on the underlying derivative, Mortimer said.

"We take credit risk into account when we assess the products," he said. "We try to assess funding levels by looking at CDS spreads and incorporating corporate debt."

Future Value also incorporates the issuer's credit profile when it scores products on risk, although that particular score mainly looks at the risk of the product's structure.

"The worse the credit situation of the issuer, the worse the value rating," he said. "It also feeds through to the riskmap."

Assessing recent products have gotten a little trickier over the past week as trouble at major investment banks set off waves in the markets, Mortimer said. But Future Value does not plan on changing its assessment system, he added.

"I think it's reflected in our methodology already," Mortimer said.

Products that will be pricing at the end of September will be harder to assess simply because the market is changing so much, he said.

"For all the products that are pricing at the end of September, nobody has any idea what the markets are going to be at that point," he said.

Closer watch on CDS spreads

Mortimer said the firm has been paying closer attention to credit default swap rates over the past year to get a sense of the issuers' credit risks.

"Until a year ago people used the credit ratings to assess the risk, but the events of the last year have underlined that the published ratings may not be accurate," he said. "You have a much more actively traded CDS market."

CDS spreads also provide analysts like Mortimer with a way to quantify the issuer's default risk, rather than just using the letter ratings that agencies use, he said.

"It gives you a more reliable reflection of what's going on, but it also gives you a direct number you can apply," Mortimer said.

Goldman offers safe play

Mortimer highlighted a recent series of absolute return trigger notes by Goldman Sachs Group, Inc. that were extremely low risk.

Goldman Sachs plans to price zero-coupon principal-protected absolute return trigger notes due 16 to 18 months after pricing linked to the MSCI EAFE index.

At maturity, the notes will pay par plus the absolute return on the underlying index, provided the index remains within a range of plus and minus 20% to 23% of the initial level during the life of the notes. The exact range will be set at pricing.

If the index trades outside of the range during the life of the notes, investors will receive par. The notes will be sold at par of $1,000.

The product's principal protection is a key reason for its extremely low risk score of 0.17 out of 10 on Future Value's scale, where 10 is the riskiest, Mortimer said.

The product offers the "possibility of return regardless of the direction of the index movement provided the barrier conditions are not breached," but "lower gearing than would be possible with a single directional product," Future Value said in its report.

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