Year ends quietly for structured products; modest volume increase seen as good news amid turmoil

By Emma Trincal

New York, Jan. 6 – The short New Year’s week was nothing exceptional as most of the structured products pricing took place during the preceding week ahead of the Christmas weekend.

Agents sold $432 million in 124 deals during the week, less than half of the previous week’s $947 million in 131 deals, according to data compiled by Prospect News.

Most sources in their outlook had predicted a flat to slightly negative issuance volume for 2015 versus the previous year. Surprisingly, volume showed a moderate uptick of 2.85% to $43.78 billion from $42.56 billion, according to the data.

Volume in December amounted to $2.81 billion, or 8.5% less than the same month a year before.

Muted growth

“December is never a great month anyway. People are travelling, they’re focused on holidays,” said a structurer.

“The U.S. equity market for the year was down less than 1% and we had a small pickup. It’s not surprising. Structured notes are supposed to be market neutral.

“Nothing to celebrate about being up 3%, but it could have been worse considering the market ups and downs we’ve seen in the second half, especially the meltdown last summer.”

Historically year-over-year issuance volume has shown more subsequent rates of increase than 3%.

For instance volume grew 11.5% in 2014 versus the previous year. Issuance surged in 2010, up 39% from 2009. The years 2008 and 2013 registered a growth of 6.55% and 8.45%, respectively. Even in 2011, one of the disappointing years, volume was up nearly 5%.

Inversely, down years typically reveal significant drops, such as 2009 and 2012 with volume down 44% and 15%, respectively, according to the data.

TLAC

The structurer said that market conditions are not always a good predictor of volume except in bear markets or during corrections as it happened in the end of August.

“Before the summer, we were up. Then we had this big sell-off and sales started to drop. It’s not a coincidence.

“The market doesn’t usually have a direct impact on volume except when things turn bad. Then people just pull out,” he said.

He invoked regulatory developments in the final quarter as factors dampening the activity in the U.S. structured note market, in particular the so-called “TLAC,” although “it’s hard to quantify the impact.”

At the end of October, the Federal Reserve Board announced its proposed Total Loss Absorbing Capital (TLAC) rules for U.S. globally systemic important banks. These new capital requirements exclude most structured notes from the definition of TLAC, which some in the industry consider a challenge for issuers of structured products.

“I’ve had a lot of discussions with people on the issuing side, even on the distribution side. I can tell you that people are seriously worried about TLAC,” the structurer said.

“The industry is innovative enough to come up with ways to go around it. But it doesn’t mean that you’ll do things the same way you used to do them before or that the same people will be involved. For those who like to cling to what they know, times are going to be tough. We’ve already seen a lot of layoffs. Either you change or you will not be successful. That’s what scares the industry.”

His view was echoed by a sellsider at a bank.

“TLAC has been horrible for U.S. issuers. We’ve seen some going out of this market completely. You can’t help thinking that the Fed is targeting structured product issuance,” this sellsider said.

“So if volume was up last year, even a little bit, I guess it’s great.”

Changing curve

The sellsider was pessimistic about current market conditions, pointing to the upcoming rate hikes combined with macro-economic developments as sources of turmoil, especially in the rate-linked note market.

“Quite frankly, we are in a major inflexion point,” he said.

“The Fed is starting to hike. Some people are starting to chase yields. Others are not doing anything.

“The yield curve is going through drastic moves.

“We’ve had the curve steepening, then flattening with the Fed hiking rates, now we’re steepening again.

“We had a tremendous amount of flattening but with Chinese markets falling apart, the trend is steepening.

“There are so many macro-economic factors – the Fed, what’s happening in China, oil, the Middle-East – we’ve seen massive log jams in flows.

“Deals we’ve been printing for the last six months all of a sudden disappeared.

“You’ve seen funding on 10-year callables at +20 [basis points], two weeks later, it’s minus 10 [bps].

“We’re seeing rating changes, layoffs... It’s been crazy stuff going on in the past six months.”

Tiny deals

Deal size was at a low point last week with the top offering priced at less than $17 million.

It was Credit Suisse AG, London Branch’s $16.9 million of two-year leveraged buffered notes linked to the S&P 500 index. The upside leverage factor was 1.5, the cap was 24.60% and the downside protection, a geared buffer of 10% with a multiple of 1.11.

The second largest deal was a five-year barrier note linked to the Energy Select Sector SPDR fund, brought to market by HSBC USA Inc. for $16.78 million. The participation rate was 144.68% and the trigger level, 75%.

UBS Financial Services Inc. was the agent.

“Those are very small deals. Nothing too exciting,” said the structurer.

The rise of income

The prevailing structure last week was reverse convertibles amounting to 37.5% of the total. Those deals were mostly contingent coupon autocallables for 33.5%. Traditional reverse convertibles represented only 4% of the overall volume.

The structurer said that those “income deals” are likely to gain traction in the upcoming year.

“The underlying doesn’t have to go up. They’re often relatively safe as the barrier can be set quite low. If it breaches, that’s because something really bad happened,” he said.

“Although they’re not as conservative as traditional bonds, they’re kind of bond-like in the sense that it takes a lot to lose money.

“I expect income deals to be more in favor this year. Rising interest rates will help pricing.

“People are embracing those deals in broader ways –they use indexes rather than stocks, even sector indices. You can do them as autocall, worst of, Phoenix. There are many ways to structure them.”

The top agent last week was UBS, which priced 26 offerings totaling $90 million, or 20.80% of the volume. It was followed by Morgan Stanley and HSBC.

“I’ve had a lot of discussions with people on the issuing side, even on the distribution side. I can tell you that people are seriously worried about TLAC.” – A structurer

“I expect income deals to be more in favor this year. Rising interest rates will help pricing.”– A structurer

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