Lehman's Clean Energy notes likely more volatile, analyst says; issuer risk not big factor in S&P 500 notes

By Kenneth Lim

Boston, May 30 - Lehman Brothers Holdings Inc.'s return optimization securities linked to the PowerShares WilderHill Clean Energy Portfolio has an unusual underlying asset that is likely to be more volatile than the broader market, structured products analyst Suzi Hampson said.

Meanwhile, the issuer risks of JPMorgan Chase & Co., Citigroup Funding Inc. and AB Svensk Exportcredit may not be significant differentiating factors in their similar accelerated growth notes linked to the S&P 500 index, said Hampson, of Future Value Consultants.

Lehman links to Clean Energy fund

Lehman Brothers plans to price return optimization securities with partial protection due Dec. 18, 2009 linked to the PowerShares WilderHill Clean Energy Portfolio.

At maturity, the notes will pay par of $10 plus double the index return if the index finishes above its initial level, subject to a maximum total return of 30% to 33%. The return cap will be set at pricing.

If the index is flat or declines by less than 10%, investors will receive par. If the index declines by more than 10%, investors will lose 1% for every 1% decrease in the index beyond 10%.

The Clean Energy Portfolio is a fund that tracks the WilderHill Clean Energy Index. The index measures the performance of companies that focus on greener and generally renewable sources of energy and technologies facilitating cleaner energy.

Notes appeal to popularity

The structure of the Lehman notes is quite straightforward, but the unusual underlying index is probably the main draw for investors, Hampson said.

"It seems like a fairly standard structure and the interesting part is obviously the underlying index, which is companies that are focused on green or renewable sources of energy," she said.

"We've seen quite a lot of products with custom indices or building strategies through funds like these, which would appeal to investors who thought that renewable or greener, clean energy and all that will increase for whatever reason. It would be investors' personal opinions that this is going to increase."

The Clean Energy Portfolio is likely to be more volatile than broader stock indexes like the S&P 500, Hampson said.

"It's got a fairly high cap, which would suggest reasonable volatility," she said. "Higher than the normal S&P 500, so that allows them to offer a higher cap. The high cap could be very attractive."

Products linked to unusual funds can become more common if demand is there, Hampson said.

"This is the first time I've seen this fund, so whether or not this will do well I don't know," she said. "But there have been certain indices that have been bigger, like the [Barclays] iShares funds, where they're always putting out products on the same fund. I would assume that's because there's demand for that. With a fund like this, it's the first time they're putting it out, so I guess it would be a wait and see situation."

S&P notes similar

Issuers also launched a trio of similar notes linked to the S&P 500 index earlier in the week.

JPMorgan, Citigroup and Svensk, which issued its notes through Merrill Lynch & Co. Inc., all announced accelerated notes linked to the stock index. Their notes all will return triple the index return at maturity if the index ends higher, and will cost investors 1% for every 1% decline in the index.

JPMorgan's notes are due June 22, 2009 and will have a total return cap of at least 20.1%. Citigroup's notes are 1.25-year securities and the return will be capped at 16% to 19%. Svensk's product is due August 2009 and will be capped at 13% to 17%.

Caps, timing affect ratings

The notes received close but slightly different scores from Future Value, which rates structured products based on its assessment of the products' value and risk.

JPMorgan's note had an overall rating of 7 out of 10, while Citigroup's note was rated 5.99 out of 10, and Svensk's product scored 5.69 out of 10.

Hampson explained that the tenor of the notes and the caps were the key factors that set the notes apart from one another.

"The one from JPMorgan has a cap of 120%, so that would naturally score higher than the Citigroup one," she said. "There's also a slight difference in timing. It would make it a little bit different on a longer dated product because you would expect the longer product to have a higher cap."

But she said the difference in the caps may not be as big of a factor when the notes are actually priced.

"Maybe on pricing date, because these are all pricing around the same time...it might be the case that on pricing date they all pick similar caps," she said. "In which case if the caps are all the same their scores would not be that different."

Future Value's assessment also takes into account the risk of an issuer default, based on credit swap levels, Hampson said. But because the notes have such a short tenor and the issuers' credit profiles are so similar, issuer risk may not be a big factor in a comparison, she added.

"I can't think that either of these three are particularly bad or good," she said. "I'm assuming they're fairly similar. Because they're only a year-long product I wouldn't think they would make that much of a difference."

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