Svensk's $10 million commodity notes tied to Dow Jones - UBS index: attractive but complex

By Emma Trincal

New York, Aug. 25 - The $10 million exchangeable commodity index-linked notes due Oct. 3, 2011 linked to the Dow Jones - UBS Commodity Index - Total Return sold by Morgan Stanley & Co. Inc. for AB Svensk Exportkredit are "complex" notes that offer advantages to investors willing to be exposed to commodities, a commodity analyst said.

The structurer must have made the deal "pretty attractive" in order to offset the risk of investing in commodities, an asset class that has turned more bearish, said Brad Zigler, research analyst at Hard Assets Investor.

The coupon is Libor minus 27 basis points, payable quarterly, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par of $10,000 plus triple the difference of the index return minus the Treasury bill yield minus a fee of 0.17% per year.

The notes are putable at any time, and the notes will be called if the index closes at 85% of its initial level or less.

Attractively priced

Among the most appealing features of the offering, Zigler cited the three-times leverage without a cap, the ability of investors to put the notes at any time and the choice of the total return underlying index, which includes the return on fully collateralized futures positions.

Even the "small coupon" is a plus to investors, he noted, as it helps pay for a negative roll induced by the cost of rolling commodity futures contracts in contango.

The underlying Dow Jones - UBS Commodity Index - Total Return consists of futures contracts on commodities that need to be rolled.

Contango occurs when nearby contracts, which must be sold first, cost less than the distant futures contracts that have to be purchased.

"The Libor coupon compensates them for that contango risk," Zigler said.

"This is not an easy deal to understand. But if you judge it by its benefits, who wouldn't want that?" he added.

The non-capped leverage was also seen as appealing by other sources.

A sellsider said that it was unusual especially given the already high leverage factor of three.

"The reason you put a cap is to lever up more. That's the trade-off," this sellsider said.

Another sellsider saw in the "tiny" coupon something not central to the structure. "It's not significant," he said. "It's not a regular interest rate you'd see in a typical structured note."

Lombard street

Despite all its advantages, Zigler said the structure was complex, which could be its main drawback.

"This note has more European turns in it than Lombard Street [in San Francisco]," he said.

"This is going to be difficult for investors to understand. And it may be difficult for the issuer to hedge."

Zigler said that commodities-linked notes are less in favor in the United States than in the United Kingdom. He attributed the trend to pending changes in U.S. regulation.

Overcoming bearishness

"Commodities don't fare well right now. Fears of a double-dip recession are making people bearish. On top of that, you have the uncertainty about how liquid the market is going to be with the potential establishment of hard trading position limits by the regulators," he said.

"This deal could be an attempt to offset those fears. By kicking up the benefits, investors may get compensated for the risk."

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