Structured products issuance weakens, hurt by roller-coaster market, short holiday week

By Emma Trincal

New York, Jan. 27 – Investors were not in the mood for structured notes in the four-day week ended Friday as reflected by the issuance volume, according to preliminary data compiled by Prospect News.

Agents sold $329 million in 99 deals in the third week of the month compared to nearly three times more the week before, which ended Jan. 15.

The $916 million prior-week figure was upgraded compared to last week’s issuance story due to last-minute filings.

Volatility

Whether the lackluster volume was due to the Martin Luther King Jr. holiday shortening the week or to the V-shape of the U.S. equity markets is a matter of interpretation, sources said, although they were inclined to designate volatility as the main culprit.

“There was volatility on the week prior to last week. Last week being a four-day week, perhaps there was a lack of focus. These things usually balance out. When there’s a pick up in the VIX, it forces people to jump back,” a sellsider said.

This source specializes in income products, which are short-volatility and as such benefit from volatility spikes. Other products, especially in equities, can see the reverse trend however as investors move onto the sidelines out of fear, he explained.

Last week began by a steep sell-off precipitated by falling oil prices and a slide in Chinese equities.

Unexpectedly, the market rallied at the end of the week, letting the S&P 500 index finish the week up 1.40%.

It was a different pattern than the prior week, with a clear downside trend.

Yields

Moves of 300 points in the Dow Jones industrial average on a daily basis whether up or down are unsettling for investors, he said.

“Those huge swings are difficult to comprehend,” he noted.

“It definitely has an impact, especially on our side of the industry as it relates to fixed-income.

“When the Fed made its move and at least began hiking last month the hope was that we would see interest rates finally starting to stabilize. You would think the 10-year [rate] would continue to rise.

“But with this month’s sell-off, it hasn’t happened.”

The 10-year Treasury yield fell 25 basis points since the beginning of the year to about 2%.

Investors will be buying more fixed-income products as a way to diversify away from equities, which represent riskier assets, he said.

“When you see that type of roller-coaster in the equity markets, there is only one place to go. All the money invested in equity will be forced to go back into fixed-income.”

In the structured product market, this development would bode well for yield-enhancement products such as reverse convertibles, autocallables, digital notes as well as plain-vanilla lightly structured structures, he predicted.

“We’re going to see more income products,” he said.

Benchmarks

The market has not reached this stage yet based on last week’s break-down in structure types.

Leveraged return notes with barrier or buffers were the most-favored types of notes with nearly 30% of the total. Reverse convertible products of all types (fixed or contingent coupon, autocallables or not) made for less than 20% of the total.

Last week investors’ bid centered on equity indexes, which accounted for 83% of the total.

“Investors shy away from deals tied to individual securities. Why take the risk of hitting the barrier?” the sellsider said.

“You don’t want to get hammered by any one anomaly. The Twitters, the oils. You get crushed with those names.”

Twitter Inc. and Amazon.com, Inc., which are among the most popular underliers for reverse convertible deals, are respectively down 25% and 11% this year. The share price of Apple, Inc. has dropped 10%.

“Investors are looking for safety in this environment. That’s why you see more well-diversified indexes.

The same reason leads investors to opt for leveraged with downside protection.

“Everybody is trying to reduce risk one way or the other,” he said.

Fed, high-yield

Paul Weisbruch, vice-president options sales at Street One Financial, said the tumbling high-yield bond market is already spilling over into stock prices and other sectors of the bond market.

“It’s been a Fed-driven market for some years now. The December rate hike was not perceived well by the market as evidenced by the sell-off,” he said.

“The market [on Wednesday morning] is off ahead of the Fed’s meeting.”

The Federal Reserve Board left rates unchanged after its FOMC meeting at 2 p.m. ET on Wednesday. The market had anticipated this given the global sell-off and downward pressure on oil prices.

The S&P 500 index fell into the red after the announcement.

“It’s definitely not an environment for issuers,” said Weisbruch.

“For high-yield, anyone who bought into the bull market probably overpaid for risk and was undercompensated for the yield.

“The share price of a company like Ultra Petroleum Corp. is now $2. Back in 2014, it was trading at $30.

“There is so much energy in high-yields. This is one of the drivers of the current sell-off. It has an impact on new issues in every corner of the bond market. That includes structured notes.”

Demand for structured notes is probably on hold in the current environment, he said.

“There’s just too much volatility in the market.

“China is kind of collapsing. Oil prices keep on dropping. We’re having a terrible month.

“Structured notes issuers are probably shelving some ideas as opposed to issuing new products. They’re sort of waiting to see what happens. Right now the risk is too high.”

Top deals

Issuers favored the use of the S&P 500 index more than usual last week, according to the data, which showed that the top five offerings were linked to this benchmark.

Deals were unusually small in size with not one issue exceeding the $20 million threshold.

Only 99 deals were brought to market versus 136 in the previous week.

Morgan Stanley priced what turned out to be the largest deal last week with $19.02 million of five-year leveraged notes linked to the S&P 500 index. The product offered three-times upside leverage, up to a cap of 72.5%. The downside was protected by a 15% buffer with a multiple of 1.1765% for every 1% of index decline beyond 15%.

Coming next was Deutsche Bank AG, London Branch’s $15.2 million of 13-month capped buffered notes tied to the S&P 500 index. The buffer on the downside was 16.5%. The upside was unleveraged and capped at 10%.

Citigroup Inc. priced the third deal with $12.88 million of 18-month notes linked to the S&P 500 index.

The payout at maturity was par plus 300% of the index gain subject to a 21.9% cap. Investors were subject to the full downside exposure.

The top agent was JPMorgan. It was followed by Barclays and Goldman Sachs.

“Everybody is trying to reduce risk one way or the other.” – A sellsider

“Structured notes issuers are probably shelving some ideas as opposed to issuing new products. They’re sort of waiting to see what happens. Right now the risk is too high.” – Paul Weisbruch, vice-president options sales at Street One Financial

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