Market rebound helps structured products pricing, sentiment; agents sell $226 million during week

By Emma Trincal

New York, Feb. 21 – As the market recovered last week, structured products investors resumed bidding on notes encouraged by strong weekly gains and more favorable pricing conditions after the fresh sell-off.

Agents sold $226 million in 109 offerings in the week ended Friday, ahead of the Presidents Day weekend, according to preliminary data compiled by Prospect News. Those figures are subject to upward revision after all deals get filed on the Securities and Exchange Commission website.

Volume for month, year

For the month through Feb. 16 sales are up 36% to $1.62 billion versus $1.19 billion during that time in January.

So far February’s notional largely exceeds last year’s, up 18.25% from $1.37 billion a year ago.

For the year, agents so far have priced $7.74 billion, a 34.5% increase from last year’s $5.76 billion.

The number of deals continues to increase as 1,882 offerings have priced so far, which is 434 more than last year.

Finally, the total volume for the trailing 12 months to Feb. 16 is also encouraging. It shows a 33.6% increase to $52.18 billion from $39.05 billion in the same period a year earlier.

Rebound

Last week’s rally dispelled some of the anxiety caused by the previous week’s equity market sell-off. The market bounced back with the S&P 500 index finishing up 4.3% for the week, which led to a recovery of most of the losses incurred during the correction seen the week before.

Bulls made a comeback, encouraged by the strong earnings and economic growth.

Meanwhile the recent pickup in volatility since the beginning of the month helped issuers price better terms on many of their deals.

Volatility helps

“The environment is very positive for structured products, and it’s a function of volatility,” said Jason Barsema, co-founder and president of Halo Investing, Inc.

“Our sales are up, more so than usual, in the past three weeks because volatility is back in the market.

“A lot of investors who never bought structured notes before came out of the woodwork and started buying a lot.

“People are trying to lock in volatility. With income notes all you’re doing is selling premium.”

Income, leverage

The distribution of market shares last week between income and growth gave a slight advantage to income.

Autocallables, whether paying a call premium or a contingent coupon, accounted for $91 million, or 40%, of the total in 76 deals. Leverage represented a third of the notional $74 million in 15 offerings.

Worst of

Demand for income is strong and often comes under the form of worst-of structures. Not everyone likes those products. A market participant said that many of the contingent coupon autocallable deals have become too complex when using low or inverse correlations to boost premium. While volatility pick up is not necessarily as beneficial for leverage as it is for boosting coupons, leverage should always prevail because everyone understands it.

“All investors want is something that can capture more returns with a safety net,” he said.

“But people get greedy. And that’s when firms start to design these things that start to play with bells and whistles and you lose the basics. A single growth note with some leverage, no cap or a decent cap and a solid buffer, these things will always add value to a portfolio.”

Pricing advantage

Barsema sees demand particularly strong for income notes because those products benefit the most from volatility surges.

“People buy growth products based on their view. With volatility up, you’re getting more premium selling your puts. However, buying the at-the-money calls is more expensive. Net/net, the terms of your notes will depend on that put/call spread,” he said.

Indexes dominate

Investors showed more interest in equity indexes last week (60% of the volume) than in single-stocks (16%).

Such trends always prevail at the end of the month when BofA Merrill Lynch closes its block trades but not necessarily in the early part of the month.

Equity indexes are in demand because they are no longer used just for participation notes. For at least a couple of years, issuers have generated income out of equity indexes.

“After a broad-based sell-off, it’s more prudent to lock in volatility on an index than on a single-stock,” said Barsema.

Bulls are back

After a stretch of six-straight sessions ending in the black, investors seem to have regained confidence.

While the S&P 500 is still down about 4.8% from its Jan. 26 peak, its price on Wednesday early afternoon was 8% higher than its Feb. 9 low.

“There’s been a switch in sentiment. People have been on a bumpy ride. At first they were scared during the sell-off. But they’re not scared about another 2008 bear market – and it doesn’t look like the market is heading that way – so they’re buying some notes,” said Barsema.

“There are some horns left in them. That’s why we see a lot of leverage with buffers on the downside.”

Higher rates

Barsema noted that the recent rise in short-term interest rates was also beneficial for structures. It allowed for shorter maturities.

“You always see better terms on a longer maturity. But as the short end of the curve keeps moving up because of the rise in short-term rates, you’re beginning to see more attractive shorter-dated notes than before.

“That’s because they’re getting more interest rate paid on that zero coupon bonds,” he said.

Not everyone is convinced that now is a good time to be back in the market. Some fear that it may be too soon.

“The relief rally has been very fast. We haven’t seen any consolidation. Money is trading in momentum again,” a trader said.

“Volatility of volatility is higher. We see bigger intraday ranges and more people trading.

“We could be in danger of retracing.”

Top deals

The top deal last week was tied to a popular basket, which has been used many times before in large block trades.

Morgan Stanley Finance LLC priced $32.38 million of leveraged notes due July 3, 2019 linked to this basket, which includes the Euro Stoxx 50 index with a 37% weight, the FTSE 100 index with a 23% weight, the Tokyo Stock Price index with a 23% weight, the Swiss Market index with a 9% weight and the S&P/ASX 200 index with an 8% weight.

The payout at maturity will be par plus 300% of any basket gain, subject to a cap of 34.65%.

Investors will be fully exposed to any basket decline.

“It’s an interesting deal. You’re getting very good upside with the leverage and the high cap. But you also don’t have any downside protection. If you don’t have to do anything on the put side, you’re always going to get very good terms,” said Barsema.

“It’s not a bad deal but not one that I would show. Probably not conservative enough for us having full exposure to the downside.”

Credit Suisse AG, London Branch priced the second largest deal with $20.5 million of 13-month leveraged notes linked to the S&P 500 index. If the index return is positive, the payout at maturity will be par plus 150% of the index return, subject to a maximum return of 16.2%. Investors will be fully exposed to any decline in the index.

“If you’re modestly bullish about the market, it’s a good note. If you want to deploy some cash to boost up your equity exposure that’s a way to do it,” he said.

Top agents, issuers

The top agents last week were UBS with $60 million in 66 deals, or 26.4% of the total, and Morgan Stanley, which also priced $60 million but in just five deals.

The top issuer last week was UBS AG, London Branch. It brought to market $36 million in 64 offerings, or 15.95% of the total.

For the year, the top issuer is JPMorgan Chase Financial Co., LLC with $1.3 billion in 232 deals, or 16.85% of the total.

“A lot of investors who never bought structured notes before came out of the woodwork and started buying a lot. People are trying to lock in volatility.” – Jason Barsema, co-founder and president of Halo Investing, Inc.

“The relief rally has been very fast. We haven’t seen any consolidation. Money is trading in momentum again.” – A trader, noting the risk that the market could turn lower again

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