October structured products issuance $4.41 billion, third most active month of year

By Emma Trincal

New York, Nov. 13 – As the year draws to a close, October showed unusual strength, ranking third in volume for structured notes issuance with $4.41 billion, according to updated data compiled by Prospect News.

It may come as a surprise since October is usually a bad month for stocks. But precisely the reverse happened, and markets hit record highs last week. Still, it would be hard to establish a correlation between sales amounts and market direction in general.

May, which topped out the year-to-date chart in issuance volume with $4.96 billion, saw the equity market tumble. In second place, August with $4.77 billion was a choppy month for stocks. And now, October is the month bulls have chosen to cheer despite unresolved issues such the trade war.

The summer paradox

“May and August are usually the top months, at least in the advisory space,” said Ed Condon, director of national sales at MCG Securities, a firm that caters to registered investment advisers.

Data tracked by Prospect News include both brokerage and advisory issuance, often pointing to slower flows in the summer. But those typical seasonal trends were different this year in particular in the advisory space which has its own seasonal cycle, according to Condon.

“Everybody expects the summer to be slow. What happens in the RIA space is advisers will drum up the business when things are slowing down. They actually do a lot of business in May in anticipation of the slow summer. I think the same applies to August because September is still a slow month.

“For October, the stock market has helped quite a bit.”

He explained how.

“There is a significant volume of autocalls in the market in general. With the rally, issues got called, injecting new money. That money was reinvested last month, which kind of boosted the business in October,” he said.

November kicked out last week on a modest note with $125 million in 59 deals, according to preliminary data subject to upward revisions.

Two big weeks

October was also very busy due to two heavy weeks following each other, which was in part the result of the calendar. During the final week of the month starting Oct. 27, 536 deals priced totaling $1.45 billion, according to updated figures. This was the “private wealth” week with JPMorgan topping as an agent taking a 25.2% share followed by Morgan Stanley nabbing 11.7% of the market. Before that however BofA Securities made its own mark closing its calendar month with 57% of the $1.11 billion tally for the week starting Oct. 20.

It is uncommon to see back-to-back weeks with notional in excess of $1 billion, according to the data.

The end of October was split into two weeks, each of which corresponding to a distinct type of offerings: the brokerage offerings and the fee-based advisory offerings, explained Condon.

“The brokerage calendar has to close earlier in the month so that the platform can process the commissions. Since BofA does more commission deals, they had to close a week earlier.

“JPMorgan is much more balanced. They do quite a bit of advisory business so they were able to close on the following week of Oct. 27.”

The two previous weeks of last month fared well too with sales over $700 million each time.

September was also a decent month with $4.34 billion, following October closely.

The worst months in volume happened to be in the first half of the year with volume improving progressively after the May and August peaks, the data showed.

Year down 17.6%

Unfortunately, those improvements are not sufficient to restore a positive balance for the year to date, which continued to lag last year with $41.43 billion versus $50.29 billion, a 17.6% decline. In dollar terms, that’s nearly a $9 billion gap, which appears unlikely to be bridged in the next seven weeks before year-end.

Late calls

Many explanations have been offered for this decline. For instance, volatility as measured by the CBOE VIX index at 12.5 is well below its long-term average. Interest rates are lower, which makes the pricing of principal-protected instruments extremely challenging. But the impact of last year’s fourth quarter sell-off is sometimes overlooked.

“October, November, December 2018 traded down so much that there was no new money coming in because nothing was getting called,” said Condon.

The S&P 500 index began to rise since the beginning of the year. But it’s not before the spring that the benchmark recouped its September peak prior to the pullback.

“It’s not enough for the market to start rallying back,” he said.

“The market has to rally to above the strike price, to these initial issuance levels, in order to get called.

“If you struck a note in August 2018, you wouldn’t get called in November because the market sold off. You probably would be missing the February call too. It sort of freezes money. You won’t be called before the spring. This is why this year’s first quarter was so weak.”

Toppish market

New money is not getting invested either, in part because the rising U.S. market could be too much of a good thing.

The S&P 500 index broke a new peak last week, finishing the week at 3,093.08.

“New money is not driving issuance right now. Markets keep on reaching new highs, which certainly makes investors a little nervous about the timing of putting new money to work,” said Condon.

Matching supply, demand

Another factor is the supply of products which fail to catch investors’ attention, according to Andrew Valentine Pool, main trader at Regatta Research & Money Management.

“We only have 5% allocated to new structured notes. Right now, we’re only replacing what’s maturing,” he said.

“It’s only 5% because we haven’t found that many unique, interesting notes coming in the pipeline consistently.

“It’s just been disappointing in the past year and I haven’t figured out why really.

“The only thing I can think of is that advisers who usually buy the notes are not that interested. If the banks could provide products that people want, sales may not be so slow.”

Defense sells

Leverage with barriers and buffers accounted for 19% of total issuance last month versus only 8.75% for leverage without any protection on the downside.

Autocallable products including contingent coupon notes and snowballs made for 42.25% of the total, which is higher than the yearly average share of 38.55%.

Also, a significant amount of structures falling into less traditional categories were priced, which include dual directional notes and digital products.

Dual directional issues for instance accounted for 97 deals totaling $377 million in October, an 8.5% share of total notional for the month. There has been a total of $2.74 billion issued this year in this structure type in 796 deals, or 6.6% of the yearly volume.

But last month saw the biggest offering of this type with BofA Finance’s $54.7 million of two-year notes tied to the S&P 500 index.

Absolute return

“We do quite a few absolute return notes, and they’re selling well,” said Condon.

“The terms of dual directional notes look better than leveraged products.

“When people buy leverage, they want to know how much they can get paid. They look at the cap, they look at the leverage. What you care the most about when you buy absolute return products is what percentage of the time am I going to make money on this. You care about making money under a wider variety of circumstances and if the odds are good, getting 4% or 5% a year is OK.”

All these popular structures pointed to a desire to achieve some level of protection or hedge a dangerously toppish market even if recent developments have brought back the bulls to the forefront. Causes for optimism include hopes in a favorable outcome in the U.S.-China trade negotiations, strong third-quarter earnings, fading fears of a recession in light of better-than expected employment figures and a Federal Reserve willing to cut rates or at least having put on hold its hawkish stance for the foreseeable future.

Digital notes are also in demand for similar reasons, he added. The most interesting type in his view are those which pay at a strike below initial price. They give investors a chance to outperform the market even if the index is negative but stays above the strike.

Scotia’s $39.9 million

Last week’s top deal was a digital product.

Bank of Nova Scotia priced $39.87 million of digital basket-linked notes due May 11, 2021. 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.

If the basket return is positive, the payout at maturity will be the greater of par plus the basket return and a digital payout of 21.1%.

Investors will be exposed to any basket decline.

“I can see why this deal was popular. There is a desire for more non-domestic issues,” said Regatta’s Pool.

“Almost two thirds of the exposure is in Europe and Japan, which are two markets that are more reasonably priced than the U.S. Since those two markets have already been beaten up, it gives you a chance to score a positive return.”

However, Pool said he would have preferred to see some form of downside protection.

Commodities deal

The second deal was a commodities issue with BofA Finance LLC pricing $21.13 million of 13-month floating-rate notes linked to the S&P GSCI Index Total Return.

The interest rate is one-month Libor minus 16 basis points, subject to a minimum rate of zero. The rate resets monthly, and interest is payable at maturity.

The payout at maturity will be par plus 300% of the sum of the index return minus fees with full exposure to the downside.

“There are so few commodities notes. Commodities have been under pressure, not just due to the higher dollar but also because certain industries have been slowing down,” said Pool.

“I like the three-time leverage.”

The notes are putable at any time, subject to a minimum redemption amount of $100,000 and will be automatically called if the index closes at or below 85% of the initial index level.

“I like the fact that the notes are putable at any time,” he said.

Market-linked step-up

BofA Finance’s parent company, Bank of America Corp., issued the third deal in $20.92 million of three-year market-linked step-up notes tied to the S&P 500 index. The notes will be automatically called on an annual observation date if the index is at or above its initial level, paying a call premium of 8.15%.

At maturity, investors will get par plus 21% if the index is up but less than or equal to the 121% step-up value and par plus the index return if it closes above the step-up value.

Investors will be fully exposed losses of the index from its initial level.

The top agent for October was JPMorgan with $813 million in 288 deals, or 18.42% of the total issued. Bank of America came second with $778 million in 57 deals, a 17.64% share.

© 2015 Prospect News.
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