Structured products issuance thin in post-holiday week amid focus on hurricane, geopolitics

By Emma Trincal

New York, Sept. 13 – Almost everything contributed to slow action in the structured products market last week as agents priced a meager $133 million in 49 deals, according to preliminary data compiled by Prospect News.

Deals priced on only four sessions as the market was closed on Monday for the Labor Day holiday.

During that weekend North-Korea launched another missile triggering a sell-off on Tuesday. The market recovered in the middle of the week but ended flat as investors awaited hurricane Irma.

Notional volume figures may be revised upward given that some deals, which priced last week, may not have been filed with the Securities and Exchange Commission, especially after a holiday. Volume during the previous week, which wrapped up August, reached $1.16 billion.

A sure sign of investors’ resiliency amid geopolitical risk and extreme weather is the S&P 500 index shedding only 0.6% on the week.

Strong disposition

“There’s a lot of talk about a bear market coming up. But the economy is still strong and we found out that the economic impact of hurricane Irma is going to be limited. The market remains bullish and a lot of the doomsday scenario is headline-driven,” said Paul Weisbruch, vice-president of options sales and trading at Street One Financial.

“I’m not so sure that the average American is as afraid as CNN.

“The VIX is back at 10, the market is at all-time highs. You can’t argue against the market.”

A regional impact

The impact of hurricane Irma on the structured products space is not fully known yet, a sellsider said.

“To some degree every firm has some presence in Florida and you have a number of brokers that are operating from there,” he said.

Three major brokerages selling structured products –Incapital LLC, ýJVB Financial Group, LLC and Advisors Asset Management – have offices in Boca Raton, Fla.

“Even if those brokers and their clients may have been affected, it’s still a regional, temporary effect. I think the impact for the rest of the country will be small,” this sellsider noted.

The event however could cause temporary disruptions.

“People are coming back and they’ll have a lot of things to focus on. But we still have two more weeks before the end of the month,” he said.

“The good news really is that it happened in the beginning of the month. If everybody is back on Friday, there’s still time to get things done.”

Low volatility

Investors continue to be motivated by income and are willing to take risk to get it. Part of the reason besides low interest rates is also the low volatility levels.

The CBOE Volatility index, or “fear gauge” rose to 12.25 during Tuesday’s sell-off but dropped by 1 point as the week ended. It is now a little bit over 10.

“We’re not in extreme bullishness but we’re still in a pattern in which every dip gets bought and dips are not long-lasting,” said Weisbruch.

“The market started to sell off at the end of August only a week or so. The next thing you know the market hits another all-time high.

Top structure

The market’s resiliency combined with low volatility and low interest rates is the recipe for the success of autocallable notes with contingency of the coupon. Those accounted for 55% of last week’s volume. So far this year, these products have prevailed, making for 37% of notional sales versus 31% for leveraged products, according to the data.

A majority of those notes use a worst-of payout and are based on two or three equity benchmarks with relatively high correlation. Stocks are less commonly employed. The main three indexes have consistently been the S&P 500, the Russell 2000 and the Euro Stoxx 50.

A trade for all markets

“The reason why those notes are so popular is because they’re going to do well in many markets,” the sellsider said.

“Right now they’re used for income by those types of fixed-income advisers or investors who need yield.

“Pricing makes sense because volatility is so low. Nothing moves. When you put together the call, the principal at risk and the worst-of you can get good income out of it.”

If those products allow firms to extract premium in the absence of normal volatility, one may think that a pullback in the stock market, elevating volatility could make the structure obsolete.

This sellsider said that he does not think so.

“I’m willing to bet that even if volatility is high, people will continue to buy them for two reasons, at least when it comes to investors who buy those products and understand them. First, they see pullbacks as an opportunity to buy at a lower entry; and second a higher volatility will give you a higher coupon.”

The fact that autocallable contingent coupon notes can be used in a variety of market conditions is at the core of their success, he explained.

“As long as you want income first and you’re not very bullish you should do well with those products,” he said.

“You don’t need the market to be up to collect your coupon.

“In order not to do well, you would need a substantial bear market.

“But most people believe that even if the market goes against you, you’re still going to get your coupon because of the barrier or you’re going to get called after the market rebounds.”

Year up 40%

Sales this year have largely benefited from the popular trend. Volume for autocallable reverse convertible notes rose 133% this year to $12.88 billion from $5.53 billion a year ago, according to the data. The great majority of these notes are worst-of with contingency of the coupon.

Issuance volume for the total market is up 39% for the year to $34.51 billion from $24.78 billion through Sept. 8, according to the data. This growth has been driven by an explosion in the number of deals, which rose from 5,761 last year to 9,124 this year, a 58% jump.

On a 12-month rolling period basis volume in the 12 months to Sept. 8 is up 30.2% to $48.45 billion from $37.22 billion in the same period a year earlier.

Top deals

Last week’s top three deals were relatively small in size, which is not unusual for a month kickoff.

The first one was distributed by Morgan Stanley Wealth Management; the second by BofA Merrill Lynch; and the third one by UBS Financial Services Inc.

HSBC USA Inc. priced the No. 1 offering with $16.21 million of 2.5-year contingent income callable securities linked to the worst performing of the Euro Stoxx 50 index, the Russell 2000 index and the S&P 500 index.

The contingent coupon annual rate was 10.1%. Payment is observed quarterly based on a 75% American barrier looking back at each day during the quarter.

The issuer has the option to call the notes on any quarterly observation date. The barrier at maturity, also set at 75% of the initial price, is observed point to point.

Credit Suisse AG, London Branch’s $16.06 million of three-year leveraged notes was the second deal. The underlying is a basket of international indexes consisting of the Euro Stoxx 50 index with a 40% weight, the FTSE 100 index with a 20% weight, the Nikkei Stock Average index with a 20% weight, the Swiss Market index with a 7.5% weight, the S&P/ASX 200 index with a 7.5% weight and the Hang Seng index with a 5% weight.

Investors will get uncapped leveraged return at a rate of 2.28 times. The downside exposure will be one-to-one.

The top agent last week was UBS with 20 deals totaling $23 million, or more than 17% of the total. It was followed by HSBC and BofA Merrill Lynch.

Barclays Bank plc was the top issuer with $22 million in four offerings, or more than 16% of the total.

“There’s a lot of talk about a bear market coming up. But the economy is still strong and we found out that the economic impact of hurricane Irma is going to be limited.” – Paul Weisbruch, vice-president of options sales and trading at Street One Financial

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