The Crossover index is comprised of the 50 most liquid speculative-grade credit default swaps (CDS) on European companies. The Rubicon zero coupon notes only pay off at maturity, after five years.
They are being sold at a substantial discount from the nominal amount, 54% to 55% at the current high spread levels in the Crossover index.
"It’s a good entry point for that trade right now, because the issue price is much lower as a result of the historically high levels on the Crossover index," said Tony Venutolo, global head of structured credit at Société Générale in London. "When the Crossover is much tighter, it costs a lot more. That means the chances of getting at least your money back is significantly reduced. The main benefit here is that the price is very low, and it therefore offers potentially attractive returns to investors."
The product could be applied to indexes with higher-rated underlyings, but that would lead to a lower payoff as the spreads on offer are lower. The notes pay an internal rate of return (IRR) of 14.25% if there are no credit events in the index. Up to 17 defaults in the index would still deliver 5.2% IRR, and 25 defaults would still deliver the nominal sum. The notes are not principal protected. A similar product based on the higher-quality iTraxx Main index of investment grade would deliver an IRR in the region of 7% to 8%, in the bank's estimation.
The fact that there has been increased interest in the notes over the past couple of weeks has been a function of increased interest in credit exposure from private clients.
"It’s an idea we came up with because we had a lot of private clients who were looking for very simple products," said Helene Schmitt, a credit structurer at Société Générale. "Its not a tranche, so there is no correlation risk and the payoff is very easy to understand. More and more clients, particularly in private banking, were asking for access to the credit market but demanding simple products."
The bank has seen interest in maturities beyond five years, but the liquidity of the five-year contracts has made it more attractive.
See also: Liffe to clear credit derivatives in Q4