Tagged: structured products

Autocallable

It’s time we had The Talk.

Candid discussions can be uncomfortable. They broach subjects we prefer to avoid. But we can’t ignore the facts of life.

One such fact is Contingent Absolute Return Autocallable Optimization Securities. We’re more comfortable talking about diarrhea, right? Bring them up at a party and the crowd disperses. Try talking to your teenager about them and she’ll roll her eyes and turn up One Direction in her ear buds.

Why the public disdain? Look at the name. Need we say more? They’re wildly popular though with issuing banks including JP Morgan, UBS, Barclays, Morgan Stanley, RBC and others – just about anyone who offers “structured products.”

This particular version of structured product (“a financial instrument crafted by a brokerage to achieve a particular investment objective for clients ranging from short-term yield to long-term risk-mitigation” is how we’d describe them) achieved both infamy and scrutiny after Apple shares slumped in latter 2012. Big banks had sold hundreds of millions of dollars of Contingent Autocallable Securities paying a yield of about 10% and tied to the performance of Apple shares. Buyers got stuck with shares that had dropped 30% in value and lost principal to boot.

I’ll give you my simplest understanding of how these instruments work and why you should care from the IR chair. It’s a debt instrument and it’s unsecured. It tends to pay high interest, like 10% annualized in a basis-points world. Whether it pays out turns on two things: How long you hold it, and whether the underlying equity to which it’s paired declines below a trigger price.

There are two problems for IROs. First, because regulators consider it debt, if it “converts” there’s no equity trade. These things are not responsible for big percentages of volume so there’s no vortex looming in your share-counts. But still, decisions and strategies impacting shares are resulting from instruments you can’t track. (more…)

Banks BARE All

Where have I been?

Somehow, I missed the fun happening in SEC filings for large banks like Morgan Stanley, Goldman Sachs, JP Morgan, Credit Suisse and Deutsche Bank.

If you already know what BARES are – Buffered Accelerated Return Equity Securities, of course – goody for you, and you should’ve said something.

What first got my attention were big quarterly earnings this period for the banks. Strip out the Financials sector and S&P 500 earnings are measly. But banking is booming. Morgan Stanley reported a 66% jump in year-over-year quarterly net income “as the investment bank bounced back from a slump in trading revenue a year earlier,” said a Wall Street Journal story.

Wait a minute. Interest rates even after upticks since May 22 when Ben Bernanke offered an impression that the Infinite Money Theorem may in fact have a terminus are so low that inflation-protected notes guarantee buyers a loss even now. If banks rely on interest…well, you don’t expect big numbers, right?

Hang on now. Morgan Stanley said these results reflect trading gains. So I checked statistics at the Securities Industry and Financial Markets Association (SIFMA, where former Republican congressman Judd Gregg has just taken the helm). (more…)