Volume is up 18.2% this year amid push in delta one deals, continued interest in autocallables

By Emma Trincal

New York, May 14 - Issuance volume grew by 18.2% to $15.32 billion this year as of Friday from $12.96 billion during the same period of last year, according to data compiled by Prospect News. The biggest pockets of growth came from tracker-like structures and autocallable reverse convertibles as well as rates-linked notes, according to the data.

"More people are adopting structured notes," said Bernd Henseler, vice president, structured products at S&P Dow Jones Indices.

"Advisers realize they can offer the client new ways to obtain the exposure."

With many issuers away in Florida last week for an industry conference and as the month just got started, last week's volume was only $371 million sold in 120 deals, the data showed.

Trackers

But the week confirmed the existence of recent trends, in particular, a stronger demand for delta one products offering one-to-one participation on the downside and upside with no optionality, products also called trackers, which some compare to unleveraged exchange-traded funds as they replicate a particular index or strategy.

Those products represented nearly a third of last week's volume issued in five offerings totaling $116 million.

"As investors get accustomed to the attributes of principal-at-risk index-linked-notes, these instruments will compete favorably against unit investment trusts, ETFs and index funds. The notes have tax efficiencies, lower costs, customizable features and can be launched within a matter of days," said Keith Styrcula, chairman of the Structured Products Association.

Delta one notes can fit a variety of portfolios and serve different purposes, according to a sellsider.

"They help them to hedge or to take a view," he said.

"Look, there's got to be more they're getting with that than with an ETF.

"Why people buy a structured note when they can do options themselves? Why do they buy mutual funds when they can buy the stocks? Probably because it's packaged and it's convenient. That would be my guess."

Delta one products, which offer none of the terms usually associated with structured products such as downside protection, cap or leverage, could be one of the drivers behind this year's growth, said Henseler.

"People are using notes as delta one replacement trades. We're seeing more and more non-principal-protected coming out, either on indices or on single stocks," he said.

Flexibility of use is also a plus from the perspective of the issuing firms.

"Delta one products are much faster to bring to market. With an ETF, you have to file some documentation and in theory, you have to operate in perpetuity. You have to support your infrastructure for the long term. That setup will have a higher cost than a note. A note will give you much more flexibility," he said.

Top deals

The largest deal last week fit into the delta one category. JPMorgan Chase & Co. priced an additional $45.44 million of 0% return notes due Nov. 27, 2018 linked to the J.P. Morgan Enhanced Beta Select Backwardation Alternative Benchmark Total Return index. An add-on of the same size was priced a week before on May 2. The total issue size is now $350.47 million. The initial issue priced on Nov. 22.

A market participant explained the benefit of issuing those add-ons.

"A lot of times, banks don't know how much they will raise in advance, if it will be $1 million or $100 million," this market participant said.

"With an ETF, you need a minimum volume to make it work, but with a note, the entry point is much lower. Given this greater level of flexibility, we will most likely see more of these delta one deals."

The second largest deal last week was also a JPMorgan delta one offering, $37.2 million of notes due Feb. 10, 2015 linked to the performance of the Stoxx Europe 600 Basic Resources index converted into dollars.

Growth, what growth?

Agents so far this year have seen volume grow for two reasons, said Henseler.

"The market went up and people became confident and engaged more in general investing, lifting the tide overall. That's one factor," he said.

"The second part is that we're seeing a higher level of sophistication on the adviser side. Advisers have become more educated in terms of explaining those products and knowing how to use them. The result is that volume has increased."

But not everyone is so optimistic. A fixed-income sellsider is skeptical.

"Honestly, it seems surprising to me that volume could be up this year," he said.

"We were just in a conference last week in Florida, and people talked about the business getting slower from last year.

"I guess it depends on what you're talking about. If you look at agencies and rates, we're down from last year.

"On our end, things have been kind of stagnant from last year. April was very slow too."

Prospect News data does not include synthetic structured coupon deals, which comprise step ups, fixed-to-floating notes and capped floaters. These products, which are also not part of the league tables totals, are counted separately. Their volume, as of the end of April, was down 38.5% from last year to $14.6 billion, according to Prospect News. Meanwhile, the volume of ETNs, which the weekly issuance figures do exclude as well, has declined by 16.5% from last year.

Rates

Standard interest-rate-linked notes with an underlying have on the other hand been increasing in volume, nearly doubling since last year to $848 million from $430 million, according to the data.

These would be steepeners linked to Constant Maturity Swaps rate spreads or to the Consumer Price Index for instance as well as range accrual notes.

Those interest-rate-linked notes made for 18% of this year's total volume increase of $2.36 billion from last year, the data showed.

Wells Fargo & Co. priced the largest rate deal last week, $26.35 million of floating-rate notes due May 9, 2021 linked to the 10-year Constant Maturity Swap rate.

Interest is paid quarterly at an annualized rate of 0.635 times the 10-year CMS rate, subject to a minimum rate of 2% per year. The payout at maturity is par.

"It's a little different," the fixed-income sellsider said about the deal.

"They take a different point on the CMS curve. But instead of getting the exact CMS rate, they give you for the seven years a percentage of the 10-year rate. The 10-year CMS is now 2.63%, so you're getting 63% of that, which would be 1.65%. Since there is a 2% floor, right now you would get 2%. As interest rates go higher or lower, you get the same fixed percentage with the 2% minimum.

"It's not bad if you compare it to a fixed-rate certificate and if you think, as most people do, that at some point interest rates will go up. It's a bearish strategy."

Autocallable reverse convertibles

Another source of volume growth seen this year is the continued bid for autocallable reverse convertibles, increasing 31.5% to $2.94 billion from $2.24 billion.

"Autocallables are very popular. People are using them as an income alternative. But they can be dangerous. If you buy them because you think it's like a bond, it's not a good idea. It's linked to the equity markets with all the risks associated with equities. Anybody who buys a barrier or a buffered note, a reverse convertible or an autocall should know that it's going to behave like a stock, not a bond. If there is a big correction, you're at risk," the sellsider said.

One trend seen this year is the smaller size of these autocallables but the multiplication of the number of offerings. The number of those offerings jumped up 48% this year to 1,224 from 827, according to the data.

"People may be using smaller autocall deals in size because they don't want to make a big commitment. You can use them as a hedge to an existing position. You can use it as an income alternative. Income doesn't have to come from a bond. It can come from dividends or from a structured product. It's fine if the investor understands them," the sellsider said.

"The deals are small because investors use it for limited parts of their portfolios," the market participant said.

In an effort to offer higher premium, issuers last week continued to price deals linked to some of the "momentum" names that have recently been under pressure, such as Tesla Motors, Inc. and Facebook, Inc.

"Some stocks are more volatile than others, but these are not necessarily reckless trades," the market participant said.

One example was JPMorgan's $14.76 million contingent income autocallable securities linked to Tesla Motors featuring 10% contingent income, a downside trigger of 80% and a one-year maturity.

"If you think Tesla will go up but you're happy limiting your upside to 10% for some downside protection, there is nothing wrong with that. It's a way to express your risk-return expectation while getting above-average yield," the market participant said.

The top agent last week was JPMorgan with 14 deals totaling $134 million. It was followed by Bank of American and Morgan Stanley.

"Delta one products are much faster to bring to market [than ETFs]." - Bernd Henseler, vice president, structured products at S&P Dow Jones Indices

"Autocallables are very popular. ... But they can be dangerous." - A sellsider

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