Structured products issuance hits $377 million for week amid sell-off, yield curve inversion

By Emma Trincal

New York, Aug. 21 – Structured products issuance was solid during the second week of the month with an unusually high amount of income products versus growth notes, according to data compiled by Prospect News.

Agents priced $377 million in 137 deals in the week ended Friday. But what a week! Fears of a recession took precedence on Wednesday when the two-year and 10-year Treasuries briefly inverted, causing the Dow Jones industrial average to plunge 800 points, or 3%, its biggest drop since the December sell-off. It was the third week in a row of weekly declines in the U.S. stock market. The S&P 500 index finished the week 1% lower.

Concerns of a global economic slowdown continued to be fueled by the ongoing trade war even after president Donald Trump on Tuesday put the brakes on the crisis by postponing some of the tariffs he threatened to impose on Chinese goods.

Vol is your friend

The CBOE VIX index, which measures market volatility, surged on Wednesday to 22.71, well above its long-term average of 19. More volatility continued to compress leverage deals and encourage short-volatility structures, namely autocallables and other income-oriented products.

“When sell-offs like the one we had on Wednesday happen, it’s a call for action,” said a market participant.

“Many people are on vacations, but for those who are not, it’s an opportunity to time the market. They see a day of heightened volatility and they try to lock in good terms. More volatility leads to higher coupons.”

Last week finished on a higher note, and so far, this week has seen fewer abrupt intraday moves, he noted.

“Roller-coaster days like last week have been more active for structured notes than yesterday when the market was slightly up or flat,” he said, speaking on Wednesday morning.

More calls, less leverage

To be sure, short-volatility products prevailed again last week. Autocallable notes with contingent coupon amounted to $200 million. Pure autocalls (snowballs) paying a call premium upon the early redemption made for $14 million. Overall, it was nearly 57% of the total notional sales that went into those notes, which are essentially income-generating products.

In line with a trend already seen last week, leverage sunk. In the absence of Bank of America’s block trades at the end of the monthly calendar, this category of notes in the current environment has recently been in decline.

Only $61 million of leveraged deals priced last week in 19 offerings, or 16% of the total. None were without some level of downside protection through either a barrier or a buffer. This product type constitutes about a quarter of the year-to-date flow on average, the data showed.

Conviction missing

For this market participant, it’s all about pricing.

“The higher vol. is compressing the terms for leverage. Those deals don’t look as appealing. Notes that sell volatility are more adapted to this type of market,” he said.

There is also the fact that the averages are close to their all-time highs. Fewer investors anticipate high returns in the years ahead.

“Snowballs, Phoenix autocalls and reverse convertibles give you higher yield and attractively priced barriers. It makes sense in a choppy market when things are trading rangebound,” he said.

“If you don’t have a conviction on this market, you want at least a good coupon and a barrier that’s going to protect you.”

Sideways views

An industry source agreed.

“You’re trying to buy value with these range notes. With rates as low as they are, autocalls are starting to look very attractive.

“We’re at a point in this environment where it’s hard to have a view. Advisers don’t want to get burned. Bulls are turning cautious. The market is choppy. As a result of that, making a bet on a range bound market makes more sense than ever.

“Of course, there’s also fear. People are worried about a bear market for the first time since December, he noted. “Many are sitting on their hands. They’re starting to look at gold, currency plays and oil.”

August is up

Volume for the month improved, a piece of good news as it hasn’t happened in some time, according to data compiled by Prospect News.

The month through Aug. 16 saw the pricing of $1.378 billion in 420 deals, an 18.8% increase from July’s $1.16 billion in volume in 297 offerings.

August so far exceeds last year’s notional by 12.4% from $1.226 billion

For the market participant, the volatility that hit the markets this month is the big contributor to this uptick.

The S&P 500 index is down 1.2% this month.

Also, August a year ago was not among the top months in terms of issuance volume. It ranked in the sixth position far behind January and February, which were both historically strong.

It’s too soon, and hopefully not yet too late to spot an improvement in the year-to-date issuance tally.

Sales so far amount to $29.089 billion, a 20.83% decline from last year’s $36.742 billion.

The number of deals is also down to 9,454 from 10,299, an 8.2% drop.

One commodity trade

Bulls on real assets will be excited to know it: last week’s top deal was a commodity-linked notes offering. It is rare to see commodities issuance lately, let alone deals of this size.

GS Finance Corp. priced $40.46 million of 13-month notes tied to the Bloomberg Commodity index.

It was a delta-one play with the payout tied to the index performance both up and down.

Commodities notes have become too rare to ignore.

“The underperformance of the asset class has not given them a lot of traction in the structured notes space,” said the market participant.

Commodities issuance volume accounts for only 0.70% of total sales in just $204 million priced in 39 deals, according to figures for this year through Aug. 16. During the same period back in 2008 when the Bloomberg Commodity index peaked, commodities issuance at $2.56 billion represented 6.4% of the total. So better times existed in the past. The current weakness, which has been the norm for years now, may not be indefinite.

Endangered asset class

The market participant, however, doubted it. To him, commodities notes are simply a hard sell to retail investors.

“We don’t see a lot of issuance. I think it’s because these deals are based on futures contracts and there is decay in the price of those contracts.

“It’s not a surprise that people would get their exposure to oil via energy stocks and not on USO.”

The “USO” acronym is the ticker of the United States Oil fund, an exchange-traded fund that tracks the performance of WTI Crude Oil futures contracts.

Notes linked to futures contracts can see their performance eroded by the shape of the futures curve when the spot price of the contracts are lower than the price of those expiring further out in time, a phenomenon known as contango. The cost of “rolling” the contracts in contango will negatively impact the returns of a long position.

The complexity of contango term structure makes those structured notes particularly challenging to explain to an individual investor, he said.

“Maybe if commodities begin to do better, we may see more issuance of those products. Honestly, I doubt it,” he said.

Shark fest

Prospect News spotted the resurgence of bearish deals, most of which were taking the shape of shark notes. Two recent ones came from Goldman Sachs, which used the concept and applied it to an autocallable format.

Shark notes allow for full principal protection over a relatively short period of time based on the high likelihood of receiving a modest gain.

When bearish, those notes provide the participation on an absolute return basis. As long as the underlying does not breach one or even two barriers during the life of the notes and finishes negative, investors will get the absolute return at maturity. If not, they will only get par plus a small bonus varying from 1% to 4%.

Most of those deals are growth products. In the past two weeks, Goldman Sachs introduced an innovation: the possibility to get called and therefore, to earn the small bonus way before the end of the term.

Goldman’s sharks

On Friday, for instance, GS Finance Corp. priced $6.18 million of bearish barrier early redeemable market-linked notes with daily barrier observation due Oct. 12, 2021 linked to the S&P 500 index. UBS is acting as an agent.

If the index closes below the barrier, 75% of the initial index level, on any day during the life of the notes, the notes will be automatically redeemed at par plus 1%.

If the notes are not automatically redeemed and the index return is either positive or less than the barrier, the payout at maturity will be par plus 1%.

If the index return is negative and above the barrier, the payout will be par plus the absolute value of the index return.

A week before, GS Finance priced another one for $344,000 also on the S&P 500 index but slightly longer as it is due on Feb. 14, 2022.

This time the barrier was at 85% but the 4% bonus was higher.

If on any day during the life of the notes the closing level of the underlier is less than 85% of the initial underlier level, the notes will be automatically called at par plus 4%.

Buy the dip

“Typically, those deals are point to point. The uniqueness of these one is the fact that it’s autocallable,” the market participant said.

“Instead of holding your money in a bond, this one also provides you with full principal protection, and if the market plunges 30%, you can deploy your funds and buy the dip.

“This is a very interesting bearish strategy. It’s not just about getting 1%. It’s getting all your cash back with the ability to redeploy it at very attractive entry levels.

“There are different ways for people to play bearish, the shark as we know it being one side.

“But doing a bearish autocall is new to me. It seems interesting.”

Top deals

The second deal last week was Bank of Nova Scotia’s $21.12 million of four-year leveraged buffered 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 19% weight, the Swiss Market index with a 10% weight and the S&P/ASX 200 index with an 8% weight.

The payout is 2.56 times the basket gain with no cap. A 12.5% geared buffer (1.14269 x leverage) is offered on the downside. Goldman Sachs & Co. LLC is the dealer.

Coming third was JPMorgan Chase Financial Co. LLC’s $21 million of 15-month digital equity notes on the S&P 500 index. This structure has increased in popularity as it offers a positive return even if the index is negative as long as it finishes above a certain threshold. In this case the threshold is 85% of the initial price, the digital payout, 6.63%. On the downside, investors will lose 1.1765% for every 1% index decline beyond 15%.

The top agent last week was UBS with $102 million in 46 offerings, a 27% market share. It was followed by JPMorgan and Goldman Sachs.

GS Finance was the leading issuer with $120 million in 22 offerings, a 31.8% market share.

For the year, the top issuer is Barclays Bank plc with 1,089 deals totaling $4.376 billion, or 15% of the total.

“We’re at a point in this environment where it’s hard to have a view. Advisers don’t want to get burned. Bulls are turning cautious. The market is choppy. As a result of that, making a bet on a range bound market makes more sense than ever.” – An industry source

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