Structured notes issuance volume up 16.3% for the year as stocks rise to new records

By Emma Trincal

New York, July 28 – As the bull run keeps on running, investors keep buying structured products.

Issuance volume is up 16.3% this year with $45.91 billion this year through July 23 compared to $39.47 bill last year, according to preliminary data compiled by Prospect News.

The best two months were in January and March with $8.11 billion and $7.96 billion.

“The first quarter was exceedingly strong, the second quarter a little less so but still holding up pretty well,” said Tim Bonacci, president and chief executive officer of Luma Financial Technologies.

Such growth took place in a bullish market, with the S&P 500 index climbing more than 11% for the year through last Friday. Since then, the benchmark has already gained an additional 7%.

Friday highs

Last week saw the pricing of 100 offerings totaling $319 million, according to the preliminary data, which is subject to upward revisions.

As it has been the pattern over the past few weeks, the U.S. stock market began the week on a choppy mode, but all indexes – the Dow Jones industrial average, the S&P 500 index and the Nasdaq-100 – were back at new record highs on Friday.

Market sell-offs have become more common. But their short length measured in two or three days rather than weeks have not led to significant premium increase in the options market. As a result, investors are not necessarily getting the same terms they had during more consistent pullbacks in the past.

“You need a few consecutive days of volatility to have an impact on the terms,” said Matt Rosenberg, director at Halo Investing.

The Dow dropped nearly 3% in a two-day sell-off last week but closed above 35,000 for the first time on Friday helped by strong earnings, notably for Twitter, Inc. The average finished the week up 0.7%.

“When we see drops in the market, it’s a fairly short window of time to get better terms. If the terms do improve, it’s usually not all that significant. The market drops and the next day, people buy the dip,” said Bonacci.

Meanwhile, the 10-year Treasury yield continued to decline, trading in a 1.19% to 1.29% range, well below its previous peak of March at 1.77%.

Seeking new asset classes

“It’s a tougher environment righty now for pricing,” said Rosenberg.

“Terms aren’t what they used to be.

“When volatility is stable, you’re not getting great opportunities on indices. You have to switch to single stocks and sector ETFs.

The bond component of structured products is also adversely impacted by low interest rates, he added.

Bonacci said he also sees an increase in single-stock deals, which are becoming more mainstream.

He pointed to new index trends as well.

“We’re starting to see more of non-U.S. underliers and a few larger deals with European exposure,” he said.

Some of this is due to the U.S. markets setting all-time highs almost on a weekly basis, which has investors concerned about high valuations.

“People anticipate more growth in non-U.S. indices,” he said.

FTSE exposure

A European deal caught investors’ attention last week.

Credit Suisse AG, London Branch priced $13.06 million of five-year digital notes on the FTSE 100 index. Morgan Stanley Smith Barney LLC handled distribution.

The structure pays a 49% digital payout. There is an 80% barrier on the downside.

This index is often seen in baskets of indexes but rarely as a stand-alone underlier, said Rosenberg.

“We don’t see too many people seeking U.K. exposure,” he said.

“Usually, investors who want international exposure go with the EAFE or the Euro Stoxx. Country-specific bets on international equity are rare.”

Big small-cap bet

Investors bid slightly more on leveraged structures last week. Those short-term notes featured full downside risk exposure and triple upside gains up to a cap.

One among those deals was Citigroup Global Markets Holdings Inc.’s $35.5 million of 13-month upturn securities linked to the Russell 2000 index with a 15.15% cap.

“It’s a pretty good size, recovery play,” said Rosenberg.

“You use the Russell to bet on economic growth, and you take advantage of the degree of divergence between small-caps and the Nasdaq.”

Even if leverage made a comeback last week with large deals such as this trade, autocallable structures remained dominant with 61% of total sales. One-third of their $195 million notional amount came from snowball products, the data showed.

Autocalls

For Rosenberg, autocalls remain popular for at least two reasons.

“People really seek to own structured products for the downside protection, and income-oriented notes give you just that,” he said.

Despite less attractive terms due to lower volatility and low interest rates, the bid on autocall is still on in a toppish market.

“Everything is a function of your market outlook,” he said.

“People don’t expect the market to keep on posting all-time highs forever. A lot of investors have a sideways view on stocks, and for them, accepting a low income with downside protection makes sense. It’s still better than most fixed-income alternatives.”

Buysiders interviewed by Prospect News routinely express their disappointment with coupon sizes and barrier levels.

Rosenberg said those developments are market dependent.

“You need to look at the current situation, not at what was pricing before,” he said.

“Yes, yields are a little bit lower. But what are the alternatives?

“The market changes. Today’s deals are not the same as in the past.”

Two Citi the American way

The top two largest worst-of deals on indexes last week were distributed by UBS on the behalf of Citigroup Global Markets Holdings.

Both deals referenced the worst of the S&P 500 index, the Russell 2000 index and the Nasdaq-100 index

Both structures offered two identical characteristics: an issuer call, and a coupon barrier observed on any trading day during the quarter, a feature known as “American barrier.”

The first one, a 2¾ year deal, priced on Monday for $47.39 million. The annualized contingent coupon was 9%. The American coupon barrier was 70% and the principal repayment barrier, 65%.

The second issue, six-month shorter in tenor, priced the next day for $32.42 million. The terms are identical except for the coupon priced at 9.3%.

“American barriers improve the structuring a little bit,” said Bonacci.

“They’re designed to bring better terms, and if investors are comfortable with it, it works out pretty well.”

Worst of five

Stocks last week made for 14% of total sales, including single stocks and worst-of.

The top deal in this asset class was Credit Suisse AG, London Branch’s $15 million of five-year snowballs on the least performing of five stocks – Apple Inc., Amazon.com, Inc., salesforce.com, inc., Facebook, Inc. and Goldman Sachs Group, Inc.

The notes will be called at a call premium of 13.2% per annum based on a 100% call level for the first three annual review dates and 60% thereafter.

If the notes are not called, investors will be fully exposed to any losses of the worst performing stock.

J.P. Morgan Securities LLC and JPMorgan Chase Bank, NA are the placement agents.

The top agent last week was UBS with $161 million in 92 deals, or 50.5% of the total. It was followed by Morgan Stanley and Citigroup.

Citigroup Global Markets Holdings was the No. 1 issuer last week; Barclays Bank plc tops for the year.

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