Structured products issuance $191 million to start month; worst-of deals eyed in choppy market

By Emma Trincal

New York, Oct. 10 – October kicked off with a meager volume of structured products issuance as firms priced 80 deals for $191 million, according to data compiled by Prospect News.

First weeks of the month are typically slow but a stock sell-off last week may have also contributed to the slow action.

Data is likely to be revised upward as not all deals are filed with the Securities and Exchange Commission by press time.

Revised figures for the previous week closing September were upbeat, showing $1.41 billion issued in 422 deals.

While this weekly volume seems high, it remains below the average for closing weeks of each month, which is $2 billion for the past nine months of the year.

Stocks down, yields rising

Investors were caught in a bond and equity sell-off last week, which pushed the S&P 500 index down 1% while the Nasdaq 100 lost 3.7%, as bond yields jumped higher and faster than most expected.

The 10-year Treasury yield hit its highest level in seven years at 3.2%.

An increased budget deficit in Italy began to rattle investors, but the main trigger for the sell-off was a report showing more jobs in September than expected. The 3.7% unemployment rate was at its lowest since 1969.

With a tight labor market and a strong U.S. economy, many feared more rate hikes ahead, the return of inflation and the end of the bull market.

Yearly volume

Volume for the year continued to exceed last year’s. Agents priced $43.6 billion through Oct. 5 versus $40 billion during the same period last year, a 9% increase.

The number of deals is up more than 15% to 12,329 from 10,694.

Worst of on indexes

One characteristic for last week was the strong presence of worst-of structures on equity indexes. Worst-of deals on single stocks were priced as well, but the majority of those structures were done on indexes, and quite often on three indexes.

Across all structure types, equity indexes represented more than 80% of the market last week, which is unusually high for the start of the month. This type of market share tends to appear as the month is closing as large block trades are being brought to market.

Ideal pricing conditions

“Volatility is up and correlations are down. These two market parameters are conducive for better pricing on worst-of whether on single stocks or indices,” a structurer said.

“Obviously if you do it with single stocks you get higher coupons.

“But people have a better understanding of indices and they see it as a more secure bet.

“The general perception on the index is that it’s unlikely to drop 30% while a stock can certainly do that.”

Top worst-of deal

The top worst-of deal last week and the third overall was brought to market by Citigroup Global Markets Holdings Inc. The issuer priced $13.3 million of 3.5-year callable contingent yield notes linked to the least performing of the S&P 500 index, the Russell 2000 index and the Euro Stoxx 50 index.

The 9% per year quarterly contingent coupon is based on a 70% American barrier (observed daily). The notes are callable on each quarter. At maturity the barrier for principal repayment set at 60% is observed point to point.

UBS Financial Services Inc. is the agent.

The use of the euro zone benchmark along with U.S. equity indexes is common. But the conditions for this combination are today better than recently, the structurer said.

“There’s a disconnect between the U.S. rallying and Europe going down, not today of course,” he said.

The S&P 500 index was down 1.55% in midday session on Wednesday, when he spoke.

That specific correlation of the Euro Stoxx and S&P, which is sometimes negative on the short end, is very good for the structure, he said.

“It’s also relatively unusual and probably temporary.

“In any event, that’s why you see more worst-of with indices, especially using the Euro Stoxx. The correlations are particularly low,” he said.

For some buysiders, worst-of deals are not necessarily welcome.

“If it’s all you’re being offered...If the Barclays, the JPMorgan, the Goldman Sachs are only doing this, you’re going to have to buy worst-of. Until someone comes out and constructs a best-of you don’t have much choice,” a portfolio manager said.

Leverage

Leverage was the top structure with more than 37% of the total issued of which 31% were structured without downside protection.

The lack of a barrier or buffer provides investors with some benefits such as more leverage or higher caps or both.

Case in point: last week’s top deal showed a structure featuring five-time leverage with full downside exposure and a 48.25% cap.

It was Credit Suisse AG, London Branch’s $27.7 million of two-year notes linked to a basket of international equity indexes.

The basket consists of the Euro Stoxx 50 index with a 36% weight, the Topix index with a 27% weight, the FTSE 100 index with a 20% weight, the Swiss Market index with a 9% weight and the S&P/ASX 200 index with an 8% weight.

“You’re missing about 3% in dividend from a total return perspective and on top of that you’re not getting a protection. It’s not that I don’t like it but I don’t love it,” a market participant said.

The underlying basket is considered to be a proxy for the MSCI EAFE index, which replicates the performance of developed markets outside of the United States and Canada.

Defensive digitals

It is used in several different ways. For instance, JPMorgan Chase Financial Co. LLC last week priced $8.11 million of notes linked to this basket (the difference was slight differences in the constituents’ weightings). The structure was a digital with a 10% buffer. Above 90% investors will get par plus 11.8%.

The second deal for the week was also a digital product showing a trigger below par in the form of Royal Bank of Canada’s $19.04 million of two-year notes linked to the Euro Stoxx 50 index.

If the index finishes at or above its 85% threshold, the payout at maturity will be a fixed return of par plus 15.65%.

Otherwise, investors will lose 1.1765% for each 1% decline beyond 15%.

RBC Capital Markets, LLC is the agent.

By placing the digital trigger at 85% of the initial price, investors can realize a profit even if the index is down as long as it does not fall by more than 15%.

The structurer said notes such as this, which offer an absolute return even if the underlying is negative at least within a predetermined range, are becoming increasingly in favor.

Pricing and sentiment

“The general sentiment is that equity markets are showing high valuations. People expect some kind of correction.

“Investors are being whipsawed but nobody expects the Dow to drop 30%.

“Volatility on the downside is very expensive, correlations are low.

“Structures are selling volatility, which gives you much better pricing.

“So from a pricing perspective, structures look better.

“But from a sentiment perspective, people know that we’re due for a correction. In this choppy market, some are waiting on the sidelines.

“That’s how volume could slow down,” the structurer said.

The top agent and also issuer last week was Credit Suisse with $57 million in nine deals, or 30.1% of the total. It was followed by Goldman Sachs and UBS.

JPMorgan Chase Financial is the No. 1 issuer for the year with $6.53 billion priced in 1,660 deals or 15% of the total.

“Volatility is up and correlations are down. These two market parameters are conducive for better pricing on worst-of whether on single stocks or indices.” – A structurer

“If it’s all you’re being offered...If the Barclays, the JPMorgan, the Goldman Sachs are only doing this, you’re going to have to buy worst-of. Until someone comes out and constructs a best-of you don’t have much choice.” – A portfolio manager on the abundance of worst-of deals

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