Structured products tally $778 million for week; three large equity deals eyed

By Emma Trincal

New York, Oct. 25 – Structured products issuance volume was relatively healthy last week with $778 million sold in 156 deals, with the flow pushed up by a few top offerings in excess of $45 million, according to data compiled by Prospect News.

In contrast, it was a rough week for the equity markets. The S&P 500 index and the Nasdaq lost 2.4% and 3.2%, respectively. Several headwinds led investors to reduce their risk exposure, which tends to be positive for structured notes issuance. With the war between Israel and Hamas, the lack of a House speaker in Washington D.C., and the continued bond sell-off, the market as a whole was in fear mode.

The top three structures last week were autocalls (38% of total sales), leverage (22%) and digitals (18%).

A strong flow of absolute return products gave this category a 14% share.

Each of the top three deals reflected one of those product types.

Three deals

Bank of Nova Scotia priced the top offering in a $70.03 million two-year leveraged buffered note issue on the S&P 500 index. The upside was 1.5x the gain up to a 21.5% cap. The straight 15% buffer on the downside offered absolute return within the buffered zone.

Morgan Stanley distributed this deal.

Digital notes have expanded not just in number but also in size as illustrated by last week’s second top deal.

It was brought to market by UBS AG, London Branch, in a $46.75 million issue of 27-month notes tied to the S&P 500 index. If the index finished above the 82.5% buffer level, the digital payout was 21.8%. Otherwise, investors were partially protected by a 17.5% geared buffer.

Callable products made for nearly $300 million last week. The largest one and third in size was BofA Finance LLC’s $45.35 million of two-year callable notes linked to the least performing of the Nasdaq-100 index, Russell 2000 index and S&P 500 index. The note paid a 10% fixed coupon and was callable monthly after six months. The barrier at maturity observed on the worst performer was 70%.

Rates, ETFs

There were no rate-linked notes last week despite a bond market under severe pressure.

In a speech on Thursday, Federal Reserve chair Jerome Powell reiterated its determination to bring inflation down to 2%, sending the message to the market that rates will be kept “higher for longer.”

The same day, the 10-year Treasury briefly topped 5%.

It was surprising not to see more rate-products issued last week, sources noted.

“There’s a lot of volatility in Treasuries. I’m sure we’ll see more rate products coming up,” a market participant said.

“The rise in long-term yields is driven by the data, and the data suggest the economy hasn’t cooled off as much as the Fed had hoped.”

On this longer part of the curve, the market is in command of the rates, said the sellsider.

“The bond market is demanding more premium for taking additional risk going longer. They’ve repositioned themselves from longer to shorter,” he said.

ETF-linked notes offered a new picture last week. After having been used as substitutes for equity indexes for the past few months, ETFs returned to their primary function: access to a specific sector.

The focus was almost exclusively on commodity bets.

Agents priced $45 million in nine ETF-linked notes, or about 6% of the notional. Nearly all of those notes referenced either gold, gold miners or energy stocks. The ETFs of choice were the SPDR S&P Oil & Gas Exploration & Production ETF; the SPDR Gold Trust, which tracks the price of gold bullion; and the Energy Select Sector SPDR fund.

Could be better

Equity issuance made for 91% of the total sold last week.

The equity market however is showing a mixed picture: uncertainty is elevated, yet volatility remains a constraint, sources noted.

A sellsider said that he was “surprised” that terms in general have not improved very much since the market moved downward this summer. Following a peak on July 27, the S&P 500 index is approaching correction territory, down more than 9%.

“Volatility is slowly picking up. I expect better terms on notes but it’s going to be slow and gradual,” the sellsider said.

“I’m surprised that coupons are not much higher. I’m not saying terms are bad. We’ve seen some progress with yields moving up, things you couldn’t do several years ago, especially on the shorter-end.

“But I think there is room for improvement.”

Some were more optimistic.

“It’s a good market for structured notes. Rates are high. Volatility is higher. You can still find notes with pretty high coupons and reasonable downside protection,” said the market participant.

Better terms however may be easier to find in other structured products, using other wrappers, such as structured UITs and buffer ETFs, he added.

“You get similar features as structured notes but with much deeper levels of protection,” he said.

Low end

To be sure, volatility spikes during a consistent period of time would change the pricing environment for the better. But for now, the contained volatility levels remain somewhat of a mystery given the domestic and geopolitical turmoil.

The VIX index has been trading in a 19-to-20 range of late, which is “nowhere close to a panicky situation,” said Steve Sosnick, Interactive Brokers’ chief strategist.

Even if the volatility index has recently increased (it rose slightly above 23 on Monday) it remains far from its one-year high of 30.81 on March 13 during the banking crisis, he noted.

Sosnick attributed this phenomenon to three factors.

“First, it’s due to the plain complacency among investors. The second factor is the high level of dispersion among stocks. You have seven high-growth stocks moving in one direction and 493 others slowing down the momentum. The net result is no volatility,” he said.

Supply/demand imbalance

The third factor may help explain why it has become harder for issuers to monetize volatility in order to produce income with reasonable barriers or buffers.

“We’re starting to see a lot of funds with volatility-selling strategies,” he said, citing buffer ETFs, call-writing strategies, covered-call or covered-put funds using short-dated options.

“There’s definitely been a greater willingness on the part of institutions to sell volatility over recent months,” he said.

Structured notes issuers may be part of the trend, he said, although he would not comment on this market, which is outside his area of expertise.

“But if those issuers of structured notes are selling options, that goes back to the marketplace and should have an impact on volatility as it depletes it,” he said.

Another factor which put a lid on volatility has been the slightly bullish bias among market participants.

“We haven’t seen a huge demand for volatility protection. It was particularly surprising during the August/September sell-off when volatility supply outstripped demand,” he said.

“Now supply and demand have come a bit more into balance. But volatility remains pretty low.”

Gold, American barrier

As it often is the case, issuers of structured notes become creative when the main tools to extract premium are lacking.

A few interesting structures came out last week.

One employed a daily observation barrier (American style) to generate a double-digit from gold prices with full principal protection.

UBS AG, London Branch priced $10.94 million of two-year barrier notes with daily observation inked to the SPDR Gold Trust. The payout at maturity was 20% if the ETF closed above 140% of initial level at any point during the life of the notes; if not, the payout was the return of the ETF, which by virtue of the upside barrier capped the return at 20%. The notes offered principal-protection on the downside.

“It’s a good deal if you have a range-bound view. Even if you get knocked out, you still get a good return. You can certainly outperform as long as gold doesn’t shoot to the moon,” said the sellsider.

Bearish autocalls

Another interesting trend was the increased use of bearish autocalls. Those products are not new, but they have recently become more visible. Citigroup, GS Finance and JPMorgan Chase Financial Co. LLC have been the most active players in this group.

Citigroup Global Markets Holdings Inc. priced a pair of two-year bearish autocallable notes last week with a 115% barrier and monthly contingent coupon. One, a worst of three indexes, priced for $20.26 million; the other, tied to the S&P 500, sold for $1.4 million. The contingent coupons were 22.24% and 10.75%, respectively.

“We’ve priced some of them,” said the sellsider.

“Bearish autocalls can give you decent returns and provide a hedge. All you have to do is flip the barrier upside down.”

The top agent last week was Morgan Stanley with $167 million in 10 deals, or 21.5% of the total.

It was followed by JPMorgan and BofA Securities.

The No. 1 issuer was JPMorgan Chase Financial, bringing to market 45 offerings totaling $150 million, a 19.3% share.

© 2015 Prospect News.
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