Structured products issuance hits $990 million for week; big digitals trades drive the action

By Emma Trincal

Issuers kicked off August with large block trades, especially big digital notes offerings bringing issuance volume to $990 million in 101 deals, according to preliminary data compiled by Prospect News. Average deal size was nearly $10 million compared to $5.11 million the week before.

Nine deals in excess of $30 million in size hit the market last week representing the three main categories of products –digitals, return enhancement and callable income-oriented notes.

The equity markets finished lower last week as Fitch Ratings downgraded the U.S. credit rating to AA+ from AAA on Tuesday. The S&P 500 index fell 2.3% on the week while the Nasdaq-100 index lost 2.9%. Long-term rates rose as a result of the downgrade.

Downgrade

“The U.S. government has just been downgraded. They have to pay higher rates to attract capital,” a structurer said.

Rising longer-term rates is unlikely to have an impact on structured notes pricing, a market participant added.

“The Fitch downgrade is not going to change a single thing. It scared some investors so long-term rates moved up. But this is temporary,” he said.

“The U.S. has some of the highest rates in the world. It’s the safest credit. No way the U.S. government is going to default as a result of this rating action. Rates will be lower soon.”

Single stocks

Last week had a relatively slow flow of single stock-linked notes issuance despite a busy earnings week.

Apple and Amazon reported their results after the close on Thursday. Amazon gained 8.3% the next day while Apple shares dropped 4.8%. Aside from a Morgan Stanley autocall deal for $17.53 million on Amazon.com, Inc. shares on the behalf of Bank of Nova Scotia, no sizeable offering tied to single stocks was spotted last week, according to data available at press time.

Overall, issuance of stock deals was just a little bit over 4% of the total.

“It’s not surprising. Banks avoid printing deals on stocks during earnings. There’s just too much volatility, too much uncertainty,” said the market participant.

Equity indexes made for 82% of total issuance volume, and ETFs, 4%.

Digital push

For structures, one characteristic of last week’s market was the unusually high proportion of digital notes, which made for 31% of the volume, nearly in par with callable notes, which represented a third. At 27%, the market share for leveraged products was higher than the average for the year, which is less than 20%.

The digital issuance consisted of nine block trades totaling $309 million.

Each one of those digital notes were structured “in-the-money,” which means that the digital trigger was below the initial price allowing investors to outperform in a slightly negative market. With the exception of one $1.17 million worst-of, the digital supply seen last week was based on single indexes, which is the norm for this structure.

Finally, unlike most callable products, last week’s digitals came with a geared buffer on the downside.

Goldman’s strategy

Last week’s top deal and largest digital offering was GS Finance Corp.’s $97.03 million of two-year digital notes on the S&P 500 index.

If the index finishes at or above its threshold level, 90% of initial level, the payout at maturity will be par plus 19.72%.

Otherwise, investors will lose 1.1111% for every 1% that the index declines below 10%. Goldman Sachs & Co. LLC is the agent.

Separately, Goldman Sachs & Co. LLC was the dealer for Bank of Nova Scotia’s $46.3 million offer. The notes due Feb. 6, 2025 and tied to the Russell 2000 index will pay a 17.38% digital return if the index finishes at or above 90%. Investors had a 10% geared buffer for downside protection.

“That’s Goldman,” the market participant said.

“They have an internal strategy. They do laddered portfolios of in-the-money digits. It’s only offered through the private bank, not available to the public.”

He offered details on the strategy, which was geared towards tax efficiency.

“Let’s say you buy a one-year and one-week digital. At maturity, that coupon is taxed as long-term capital gain, not ordinary income. They do a bunch of them with staggered maturities, all longer than one year. Everything is subject to long-term capital gains, not income tax. If your tax bracket for ordinary income is 40% versus 20% for long-term capital gains, you can save a lot. In terms of return, a tax equivalent yield will give you an extra 1% to 1.5%. You can increase your yield by paying less taxes. That’s the concept.”

More digitals

Other issuers jumped in the digital bandwagon last week with big offerings in the $30’s.

Canadian Imperial Bank of Commerce priced two other in-the-money digital notes on the S&P 500 index for $39.1 million and $36.8 million respectively. Meanwhile, JPMorgan Chase Financial Co. LLC issued another digital issue on the Russell 2000 index for $35.93 million.

“These are good trades for people anticipating that the market is toppy,” the structurer said.

“If you don’t expect much more upside and want to be cautious on the downside, you can take some of your equity holdings off the table and put them in that kind of trade.”

Leveraged return

Leveraged notes issuance did well last week thanks in part to two block trades linked to an unequally weighted basket of international equity indexes consisting of the Euro Stoxx 50 index, the Topix index, the FTSE 100 index, the Swiss Market index and the S&P/ASX 200 index.

Scotia Bank priced one of those basket notes for $73.56 million due May 12, 2025 paying 3x the upside up to a 39.6% cap. There was no downside protection. Simon Markets LLC was the dealer.

GS Finance priced $65.69 million on the same basket but with a 15-month tenor. The upside leverage factor was 4x and the cap, 24.48%. Investors also had full downside exposure.

Hard-earned coupon

On the income side, UBS priced two callable note offerings with a daily observation for the coupon barrier and discretionary calls on any quarterly observation date. The underlying for both issues was the worst performing of the Euro Stoxx 50 index, the Russell 2000 index and the S&P 500 index.

CIBC issued the first one for $45.51 million with a maturity date of May 7, 2026. The contingent coupon was 11.28%, the American coupon barrier, 70% and the barrier at maturity, 60%.

The second one came from Barclays Bank plc which issued a $41.49 million issue with the same tenor, coupon barrier and final barrier. The contingent coupon was 11.56%.

“Those deals have too many excuses: no no-call period, issuer callable, worst-of, daily observation. That’s not very impressive,” the structurer said.

Issuer calls

The market participant declined to comment on the deals other than to say that issuer calls were “not as bad” as they appeared to be in general.

“Issuer callable notes live longer. Banks typically don’t call on the first call date,” he said.

That’s because when volatility is at record low levels as it is now, “it can’t go much lower,” it is expected to rise, which means stock prices will fall. In such scenario, issuers have no incentive to call, he said.

“Those no-call features make sense when you price a note in a high-volatility market. If VIX is at 25 or 30 instead of 13 to 16 now, that’s when investors want to extend. You want a no-call period of nine-months to a year because in all likelihood, volatility is going to go down and the market is going to be higher. You don’t want to be called too soon. The idea is to keep the terms you have especially since you locked them when volatility was high, at a nice premium.”

Year-to-date issuance through Aug. 4 is down 2.8% to $53.68 billion in 12,344 deals from $55.24 billion in 17,006. The gap is narrower than just a few months ago, the data showed.

Last week’s top agent was UBS with $239 million in 61 deals, or 24.1% of the total.

It was followed by Goldman Sachs and JPMorgan.

The No. 1 issuer was GS Finance Corp., which brought to market four deals totaling $200 million, a 20.2% share.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.