Structured products tally down year to date, but February issuance surges from January

By Emma Trincal

New York, Feb. 22 – Structured products issuance volume for the year to date through Feb. 17 has dropped 26.5% to $9.15 billion from $12.44 billion at the same time a year ago, according to preliminary data compiled by Prospect News.

But when sticking to this early part of the year, February compared to January is very encouraging. The $3.34 billion tally for this month through Feb. 17 jumped 69% from $1.95 billion during the same period last month.

Those figures include roughly the first half of each month, which precludes any conclusion about the monthly trend so early on in the year.

Rolls

The surge seen in February may be attributed in part to rollovers from maturing notes as tracked by Prospect News.

A total of $6.26 billion was expected to mature in January compared to $7.1 billion in February, a difference of $840 million of possible reinvestments.

In addition, issuers so far this month priced more deals than they did in January – 558 and 390, respectively.

Rates rising

But the sudden change in the market direction from upward last month to downward since a Feb. 2 year-to-date peak is also relevant.

“The primary factor is that rates went up a lot this month. You have more funding to price better terms,” said a structurer.

The two-year Treasury rate on Feb. 2 was at 4.63%. In the middle of last week, it hit 5.11%.

One Feb. 15, the yield on the six-month T-bill crossed above 5% for the first time since 2007, according to Schwab research.

High inflation headlines last week pushed up Treasury yields, especially on the short end of the curve, pushing volatility higher in the equity market. The sell-off picked up in magnitude on Feb. 21 after the long Presidents Day weekend.

Volatility up

“Rates came down in January and picked up in February. That combined with a little bit more volatility, especially last week and this week, was bad for the stock market but probably a plus for issuers of structured notes,” the structurer said.

From the release of CPI numbers on Tuesday of last week to this past Monday, the S&P 500 index dropped 4%.

Volatility this month increased significantly from January, not only helping pricing but motivating investors, he said.

“People got spooked and jumped into structured products,” he said.

The VIX index posted a one-year low on Feb. 2. at 17.06 but has gained more than 6 points since.

“The market now realizes that the Fed may hike the rates longer than previously anticipated. Good news can be bad news. With a higher PPI than expected, a higher CPI and a hot job market, the consensus is that rates are going to stay high for some time. This is not good news for the market,” he said.

A sellsider offered an additional explanation.

“Vol. was so low last month, some issuers closed down their deal. I mean by that they priced it and kept the initial bidders but closed off additional orders. It certainly could have been a factor behind the slower pace,” he sellsider said.

Barclays’ recovery

Barclays is now in second place for the year through Feb. 17 with $1.21 billion in 220 deals, just behind Citigroup Global Markets Holdings Inc.’s $1.36 billion in 239 offerings. During the same period last year, Barclays ranked fourth despite the fact that its U.S. issuance platform would shut down a month later.

“They’re trying to make up for the long time they were not issuing anything last year,” the structurer said.

“Maybe they’re offering better terms. Since they were closed last year, they may be in a better position to price aggressively because they don’t have much risk on their books.”

He mentioned another factor.

“Investors pay attention to credit risk exposure. They may be drawn to Barclays to diversify across different credits since the bank did not issue anything for almost half of the year,” he said.

Short-term deals

One consequence of higher short-term rates is to make the terms of shorter-dated products much more appealing than before, the sellsider said.

“For so long, rates on the short end were basically at zero. Now shorter-dated deals are gaining traction because you’re getting real yields and you don’t have to hold the paper for very long.”

This is an advantage. But it can be detrimental as well since other options exist on the bond market.

“The 26-week and 52-week U.S. Treasuries are yielding above 5% free of state and local income taxes,” said Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments.

“The best bargain in the world today is locking in 5% or more guaranteed by the United States government. Why most investors prefer to take risks in the financial markets at such high valuations is almost entirely out of habit and lack of understanding rather than because there is any valid reason for doing so,” he added.

Structuring desks have to be “mindful” about the competition they face from risk-free government bonds or even bonds in general, which guarantee the full return of principal to investors, the sellsider said.

“Now you have to be looking at that because there is a meaningful yield pickup from traditional fixed-income and with the equity component you put in a note, you’re creating more risk,” he said.

“When you see bonds yielding 5% or 6%, you have to pay attention to that.”

Big lookback

Last week’s top deal brought back an almost forgotten feature: the lookback, which allows investors to lock in as the initial price the lowest closing price of the index during a limited period of time.

HSBC USA Inc. priced $38.08 million of two-year lookback trigger leveraged notes tied to the S&P 500 index.

The initial index level is the lowest closing level of the index during the first two months.

If the final index level is greater than the initial level, the payout at maturity will be 1.5 times the index gain capped at 21.5%.

The principal repayment barrier at maturity is 80% of the initial level.

Morgan Stanley Wealth Management handled distribution.

Fixed coupon

Another deal over $30 million in size was Canadian Imperial Bank of Commerce’s $30.64 million of 15-month 7.6% trigger callable notes with monthly interest payments linked to the worst of the Russell 2000 index and the S&P 500 index.

The notes are callable at par on any monthly coupon payment date after three months.

The barrier at maturity is 60%. UBS Financial Services Inc. is the agent.

“It’s pretty attractive for something close to a year with a deep barrier,” said the sellsider.

“They pay a fixed interest rate, so you have no coupon risk. The issuer call was necessary to price those terms, but they give you at least three months of fixed coupon, which is good.”

Buffer and memory

Citigroup Global Markets Holdings Inc. issued $20 million of a two-year autocallable on the S&P 500 index.

The monthly contingent coupon is 11.35% and is paid based on an 85% threshold. Investors receive any previously unpaid coupons. The autocall can be triggered on any monthly determination date.

At maturity, the protection is delivered via a 15% geared buffer.

Morgan Stanley distributed the deal.

“We see more and more clients demanding buffers at maturity on income products. Of course, it can be done but you’ll get a smaller amount of protection like here ... 15% on the downside instead of the 30% or 40% with a barrier.

“But they also give you 11.35% and it’s just the S&P. The maturity is also very short, and you get the memory. All of this can be done because of the skinny size of the protection,” the sellsider said.

The top agent last week was Morgan Stanley with $206 million sold in 32 deals, or 37.3% of the total.

It was followed by UBS and JPMorgan.

Barclays Bank plc was the No. 1 issuer with 23 deals totaling $109 million, a 19.7% share.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.