Calendar, government shutdown, lack of rollovers keep structured products market quiet

By Emma Trincal

New York, Oct. 9 - Agents sold $378 million in 94 deals last week, a slow pace. While not unusual for the start of a month, the slow pace was aggravated by the deadlock in Washington and the scarcity of rollovers, sources said.

After the government shut down on Tuesday, the market declined, with the S&P 500 index finishing the week down 1.25%. The VIX index, or fear gauge, which measures implied volatility on S&P options, gained 8%.

"Is it the calendar or Washington? It's anybody's guess," a market participant said.

"Except for August, volume hasn't been very strong this summer.

"What has been happening in Washington in the last few weeks is just making things worse."

A sellsider agreed.

"We're in between the month-end calendar and the beginning of a new month, so unless you have a one-off trade, you're not going to see a whole lot of volume," he said.

"The government shutdown obviously doesn't help. Overall, we've felt the impact, and there is a sense here on the desk that people are on the sidelines, not only with structured products but all markets. They are not willing to commit to new investments until things are cleared up."

The uncertainty in the markets was already in place in the late spring after the Federal Reserve telegraphed a possible winding down of its monetary policy stimulus, the market participant said.

No calls, no rolls

"Volume started to suffer since June with the Fed tapering talk. Rates have been selling off. With the 10-year [Treasury] yield climbing, notes didn't get called. You didn't have the rollovers. People remained invested. It's much easier to get a client to roll over than to have them put new money in the market. So that's what has been going on even though rates have somewhat declined since then," he said.

This market participant explained that the improved pricing conditions induced by higher rates were either too short-lived or not sufficient to motivate investors.

"Higher rates have offered pricing advantages," he said.

"You're able to buy more participation. A zero bond will have a deeper discount. It gives you an opportunity to purchase more leverage. If you combine longer maturities and higher rates, it allows you to do more.

"But the problem of having no rolls remained. It's hard to attract new money.

"Rates since then have rallied back, and we went from 3% to 2.6% on the 10-year.

"It takes time for people to take advantage of better terms and commit new money to the market. Investors in structured bonds don't throw money like that. It's like you just don't look at a house and buy it. It takes a while for people to get comfortable.

"The trajectory felt like we were getting higher yields, and people sort of watched and stayed on the sidelines."

Year-to-date volume up

The volume for the year through Oct. 5, however, was more encouraging. Issuance rose by 2.11% this year to $28.85 billion from $28.26 billion last year, according to data compiled by Prospect News.

"We were talking about it recently. Our fiscal year ends at the end of October. We are looking back at last year and overall, I think our activity is up at least 15%," the sellsider said.

"I think it's an amazing accomplishment given that we are totally a retail shop. It's been for retail a very, very difficult regulatory environment, especially for these products.

"Structured products, because of their complexity, have been under the microscope for some time, but the regulators' focus has intensified, especially in the past 12 to 18 months.

"We've seen it having an impact with more or less intensity depending on the structure.

"In retail, you have the gatekeepers, the compliance people who are responsible for monitoring the suitability for all products. Structured products are under a heavier scrutiny, and we've seen a pattern of inconsistency from individual to individual in terms of how they view or understand what complexity really is.

"As managers, it's important to talk to the advisers and shed some light on what these products are and more importantly what they are not. Too many people have a tendency to see these products as bad."

Longer tenors

Sources have noted that some products show longer durations.

For the sellsider, the change may reflect a more conservative approach to structured investing.

"We see a change in the mix. People are moving away from the short-term products, from the more speculative items into a more appropriate way of using the products. They use longer-term notes adjusted to a kind of core overall asset allocation," he said.

"I'm not saying that people should put 100% of their exposure in structured products. It doesn't make sense. But a 5% or 10% allocation can give you a chance to either protect some of your assets or outperform the market with leverage."

Investors who are willing to purchase longer-dated products may have realized that structured notes are not meant for the short term, he added.

"Structured notes are not trading vehicles. If you want to speculate, you're better off with options. Options' price sensitivity makes them more suitable for trading. Structured products are different," he said.

"For instance, you're getting leveraged exposure inside of a structured note with a multiple of call spreads. A two-times leverage factor means that you own inside the note two call spreads.

"Those two call spreads are not very sensitive to the price compared to one call option. You'd be better off buying one call if you're inclined to trade."

Finally, longer terms allow issuers to enhance some of the benefits of a note, such as eliminating the cap or protecting the downside with a lower barrier or a buffer, he said.

"Investors like the no cap. We get calls frequently for principal protection with no cap," he said.

"These are harder products to produce in this low interest rate environment. There are very few issuers that can create that at all.

"If you throw in a very low European barrier, you can get a five-year note with a 60% barrier. That's enough downside protection to get people interested."

Top offerings

Last week offered a couple of examples of products slightly longer than average for the type of structure being employed, according to the data.

One was a worst-of and the week's top deal: Credit Suisse AG, London Branch's $23.25 million of contingent coupon callable yield notes due Oct. 10, 2017 linked to the S&P 500 index, the Russell 2000 index and the iShares MSCI EAFE exchange-traded fund.

The notes pay a contingent quarterly coupon at an annual rate of 8% if each component closes at or above its barrier level, 60% of the initial level, on the observation date for that quarter.

The notes are callable at par plus the contingent coupon on any interest payment date.

The final barrier is 60% of the initial price. If breached by any of the components, investors are fully exposed to the decline of the worst performer. Barclays was the agent.

"It's a four year, but you get a 60% barrier, and that's probably why," the sellsider said.

The No. 4 deal, a dual directional note, also had a relatively long tenor. It was Morgan Stanley's $18.19 million of 0% dual directional Trigger Performance Leveraged Upside Securities due March 29, 2019 linked to the S&P 500.

If the index finishes above the initial level, the payout at maturity will be par plus 110% of the index gain.

If the index finishes at or below the initial level but at or above the 65% trigger level, the payout will be par plus the absolute value of the return.

Otherwise, investors are fully exposed to any losses.

The top deal of the week was commodities-based. It offers full principal protection, a type of structure that has become rare. Principal-protected notes represent less than 1% of this year's volume in 33 deals totaling $177 million, according to data compiled by Prospect News.

Bank of America Corp. priced $21.56 million of 0% Market Index Target-Term Securities due Sept. 24, 2019 linked to the Merrill Lynch Commodity index eXtra - Excess Return.

Investors have a one-to-one exposure to the index up to a 71% cap. The payout will be par if the index falls.

Autocallable reverse convertibles were the most widely used structure last week, making for 37% of the total in 41 deals totaling $140 million, according to the data.

Royal Bank of Canada priced one of them with the No. 3 deal of the week in its $19 million of contingent income autocallable securities due Oct. 9, 2014 linked to JPMorgan Chase & Co. shares. The coupon barrier is 80% on a quarterly determination date, and the contingent payment is 1.825% per quarter. The same 80% threshold applies at maturity for the final barrier. The notes are callable on any of the first three quarterly determination dates. The call threshold is the initial price. The deal was distributed by Morgan Stanley Smith Barney LLC.

The top agent was Morgan Stanley with $71 million, or 18.75% of the total in 10 deals. It was followed by Barclays and Citigroup.

"It takes time for people to take advantage of better terms and commit new money to the market." - A market participant

"Structured notes are not trading vehicles." - A sellsider

© 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.