Structured products agents price $344 million for week as bull market now longest in history

By Emma Trincal

New York, Aug. 29 – The surprise equity market rally this summer did not pause last week with U.S. benchmarks hitting new record highs. This week on Tuesday, Consumer Confidence jumped to its highest level in nearly 18 years, according to the Conference Board.

On Friday, the S&P 500, Russell 2000 and Nasdaq Composite indexes closed to record levels. The S&P 500 finally broke its Jan. 26 record, closing at an all-time high at 2,874.69, two days after the bull market became the longest in history.

The buoyant market mood since the end of June has helped push issuance volume higher.

Agents last week priced a third of a billion dollars in 144 deals, according to preliminary data compiled by Prospect News. It was not even the closing week of the month.

In addition, figures are likely to be revised upward as not all deals were filed with the Securities and Exchange Commission by press time.

“It’s not what I would call the doldrums of summer,” said Andrew Valentine Pool, main trader at Regatta Research & Money Management.

“Sell in May and go away would have been a terrible thing to do this year. Investors who followed that mantra would have missed a lot of upside.”

The market is having a positive impact on structured notes sales, he said.

“A few months ago, about half of our clients remained aggressive while the other half was concerned about a pullback and wanted to hedge. Now that group of cautious investors seems to be willing to take risks again,” said Pool.

Month, year

So far, the month through Aug. 24 sees a higher notional than July with $1.75 billion versus $1.64 billion last month, a 6.7% increase. The number of deals was about the same from 620 to 613.

The year is still robust even though the advance versus last year is progressively shrinking as the year nears its final months.

Agents have priced $36.22 billion so far through Aug. 24, a nearly 10% increase from $33.07 billion sold last year during the same period. The number of offerings is up 18.5% to 10,165 from 8,580.

Worst-of structures

The main structure last week continued to be autocallable notes with contingent coupon. The bulk of those deals in volume were worst-of, with the largest trades based on two or most often three indexes. Alternatively, investors bid on single-asset deals with the coupon generated by the premium of a fairly volatile stock, mostly high-performing technology names, the data showed.

The top worst-of structure was brought to market by Wells Fargo & Co. in $10.05 million of two-year autocallable contingent coupon linked notes tied to the least performing of the S&P 500 index, the Russell 2000 index and the Euro Stoxx 50 index. The contingent coupon was 8.5% a year based on a 75% coupon barrier observed quarterly.

The autocall was set on a quarterly basis at par. The principal repayment barrier was at the same level as the coupon barrier.

Stocks pop up

Overall autocallable contingent coupon deals made for 40% of the total, or 92 offerings totaling $135 million. Because some investors are saturated with worst-of, the number of single-stock deals was notably high, accounting for nearly 19% of total issuance volume. All single-stock deals (except one for $1 million) fell under the autocallable contingent coupon structure type.

Leveraged notes were the second largest category of products with 16 deals totaling $82 million, or just about a quarter of total volume. Interestingly all those deals offered a buffer or a barrier, signaling that the need for protection is still strong.

PPNs make a comeback

But the main structural characteristic of last week was an unusually strong amount of fully principal-protected notes across various asset classes. Most of the spike in principal-protected notes or PPNs came from the two largest deals, which seemed to have been part of a block trade as they had the same structure and maturity dates.

The structure is relatively new in the market and consists of being short volatility with the expectation that the underlying will trade within a range. Investors get one-to-one participation with absolute return defined by a lower and upper barriers if the underlying never moves outside of the range during the life. If it does, investors receive their principal back in full plus a bonus coupon. Therefore, they are guaranteed to earn at least the coupon or more based on the extent of the index price moves with a cap equal to the barrier level on each side.

Citi and Scotia

Citigroup Global Markets Holdings Inc. priced the top deal and one of the pair of absolute return PPNs with a $54.88 million trade. The two-year notes are linked to the S&P 500 index.

A barrier event occurs if the closing level of the index is above or below its initial level by more than 19.75% on any day during the life of the notes.

If a barrier event has occurred, the payout at maturity will be par plus 2%.

If a barrier event has not occurred, the payout will be par plus the absolute value of the index return, subject to a minimum payout of par and a maximum payout of par plus 19.75%.

“I can’t say that I have seen these kinds of deals before. It seems like underwriters are getting more creative,” said Regatta’s Pool.

The second offering mimicked the previous one showing an identical structure. The only differences were the issuer and dealer – Bank of Nova Scotia and Goldman, Sachs & Co. LLC, respectively – as well as the $54.68 million size.

Volatility play

“It’s almost the same price. Just a $200,000 difference,” said Pool.

“There is an adviser out there who thinks that volatility can be contained in that 40 percentage points window. If it is and if the market is still moving, you can make money up to 20% both ways. That’s pretty attractive. But if the market is too volatile, you won’t do much. At least they’re giving you a 2% bonus.

“The fact that you can get that extra 2% coupon and your principal back shows me how much the interest rate environment has changed.

“With higher interest rates it’s becoming easier to do principal-protection.”

A sellsider noted that the structure however was not a pure participation play but rather a bet on volatility.

“You’re not betting on the direction of the index but on the amplitude of its moves. Rates are higher but still not high enough to let you do that type of protection with leverage or even delta one on the upside. If you take the S&P 500 and give one-to-one on the upside with full protection, the numbers are not there, at least not on a two-year. You would probably have to stretch the maturity to seven years,” he said.

Rates

Another surprise last week was the pricing of a large interest-rate linked note deal, another form of gaining full principal protection although in a very different way than through equity derivatives.

Barclays Bank plc priced $30 million of three-year floating-rate notes linked to the Consumer Price Index.

The interest rate, payable monthly, will be equal to the annual percentage change in the index plus 80 basis points.

The payout at maturity will be par.

This deal was the fourth one last week.

It is worth noting that last Monday this week, Morgan Stanley priced for the same amount the same deal, only the spread was at 0.82% versus 0.80%.

“I don’t know.... If you’re going to be fully protected, why not take more risk? Take the Nasdaq instead of the CPI. It may not be easy to price. But it’s an easy sale. Who wants to have cash tied up for three years on a variable rate based on inflation? You can get dividends on stocks. Even the three-year Treasury pays 2.75% and it’s a guaranteed rate with a fully liquid instrument,” said Pool.

EAFE-like basket

GS Finance Corp.’s $34.72 million of two-year leveraged buffered notes linked to a basket of indexes was the No. 3 offering last week.

The unequally weighted basket consists of the usual benchmarks: the Euro Stoxx 50 index, the Topix index, the FTSE 100 index, the Swiss Market index and the S&P/ASX 200 index in decreasing weighting order.

The payout at maturity will be par plus double any basket gain, up to a cap of 28%. There is a 20.05% geared buffer on the downside with a 1.2508% multiple.

The top agent last week was JPMorgan with 18 deals totaling $60 million, or 18% of the total. It was followed by Goldman Sachs and Barclays.

GS Finance Corp. was the top issuer with $54 million in 10 deals, or 16.22% of the total.

The top issuer for the year is JPMorgan Chase Financial Co. LLC with $5.69 billion in 1,414 deals, or 15.7% of the total.

“It’s not what I would call the doldrums of summer. Sell in May and go away would have been a terrible thing to do this year. Investors who followed that mantra would have missed a lot of upside.” – Andrew Valentine Pool, main trader at Regatta Research & Money Management

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