Investors flee S&P 500 for more volatile bets in dull pre-holiday week; year remains strong

By Emma Trincal

New York, May 27 – The week that ended Friday ahead of the Memorial Day weekend was the smallest in volume for the year so far with $287 million sold in 66 deals, according to data compiled by Prospect News.

But pricing will take place this week, and so far, May already is well ahead of April volume-wise with $1.64 billion sold as of Friday versus $1.21 billion last month, a 35.50% increase.

Compared to a year ago, this month is also much more robust, up 28.20% from $1.28 billion in May 2014, according to the data, which only includes structured notes registered with the Securities and Exchange Commission. The data also ignores exchange-traded notes and lightly structured rate notes such as Libor-based products.

Year is up

For the year as of Friday, agents sold $18.51 billion, a 15.33% increase from last year’s $16.05 billion.

Each month so far has seen strong issuance volume, including March and April with $4.17 billion and $3.96 billion, respectively. April tends to set the pace for a weakening trend in most years, which typically lasts through the end of the summer, but it was not the case this year. January is the top month so far with $5 billion, followed by March and April. February is No. 4 with $3.69 billion.

Asked about the factors behind the strong volume so far, a sellsider said, “I would guess it’s because rates are sitting in such a low level. People need yield. The only way to get yield outside of the traditional mix of asset classes is through structured notes.

“I bet autocallables are one of the most popular structures.”

Autocallables indeed make for more than 35% of the total sold this year, the data showed.

“People are tired of rolling their one-year, two-year bullet CDs. They need more,” he said.

Rates

With Fed chair Yellen indicating on Friday that “it may be appropriate” later this year to raise rates if the economy continues to improve, investors continued to look for yield in rate structures, a recent trend that Barclays Bank plc illustrated when it issued more than $142 million of notes linked to the 30-year Euro Constant Maturity Swap rate two weeks ago.

“The market is obviously looking for higher rates,” the sellsider said.

“When someone put [out] a deal with an attractive coupon, people will absolutely pile into it.”

He noted that some banks are getting attractive funding rates internally, allowing them to offer competitively priced deals.

Three rate deals priced last week among the top seven, representing 20% of the volume, which is far more than the less-than-4% average for this year.

Wells Fargo & Co. priced $34.48 million of fixed-to-floating-rate notes due May 21, 2027 linked to the 10-year Constant Maturity Swap rate. It was the No. 3 offering. The interest rate was 4% for the first three years. After that, a floating rate equal to 0.82 times the 10-year CMS rate applied. Interest was payable quarterly.

The payout at maturity was par.

Wells Fargo Securities, LLC was the agent.

Two other 10-year fixed-to-floating-rate notes linked to the 10-year CMS rate were also sold, one for $12 million issued by Citigroup Inc. and the other brought to market by Morgan Stanley for $10 million.

Weak interest in S&P 500

Investors did not rush into S&P 500 index-linked deals last week as they usually do. Instead, they favored underlying benchmarks or funds with greater volatility, sources noted.

Only two S&P offerings priced totaling $4.65 million. The notional for the year is $1.77 billion, or nearly 10% of the total volume in 298 deals, according to the data.

Bids were more significant on notes linked to the Euro Stoxx 50 index or the Russell 2000 index.

“The Russell is certainly pricing better,” said Tom May, partner at Catley Lakeman Securities.

“Clients inherently sell volatility. They may be able to get more premium for selling the puts they need for the downside protection.”

Two over $40 million

Credit Suisse AG, London Branch priced the top deal last week, $47.8 million of three-year autocallable buffered notes linked to the Euro Stoxx 50.

The notes were callable on either of two annual call observation dates if the index closed at or above its initial level with an 8.6125% call premium for the first call and 15.9% for the second call. At maturity, investors received a 23.85% premium under the same condition. There was a 15% geared buffer on the downside with a 1.17647 multiple. Credit Suisse Securities (USA) LLC was the agent.

“The Euro Stoxx is definitely more volatile, and dividends are higher. That helps pricing. You give up more dividends, and you get something more in exchange,” said May.

Some argued that investors are beginning to fear that the S&P 500 is overbought.

Just last Thursday, the benchmark hit a new record at 2,130.82.

But May said that he is not sure why investors showed so little interest in the U.S. benchmark.

“The S&P is the one that has had a very good run. Possibly, they may want to diversify. But we’re still pricing a lot of business on the S&P,” he said.

Deutsche Bank AG, London Branch’s $47.7 million of three-year autocallable buffered notes linked to the Russell 2000 was the second largest deal of the week. With almost the same size as the first one, it had the same structure with call premiums of 8.125% for the first observation date and 15% for the second call. At maturity, the premium was 22.5%. The same buffer of an identical amount and leverage multiple applied. The agent was Deutsche Bank Securities Inc.

Seeking vol

For the sellsider, pricing was the main factor behind the popularity of those two non-S&P deals.

“It’s definitely a volatility issue,” he said.

“If people are focusing more on the Russell, it’s definitely a volatility play. The Russell is incrementally more volatile. It produces better-priced deals. I don’t think it’s related to diversification and people being concerned about the recent highs of the S&P. You can’t worry about the S&P and use the Russell. The correlation is very high,” he said.

Volatility was also at play with the Euro Stoxx deal 50, he added, pointing to a 100-day historical volatility of 12.73% for the S&P 500 versus 18.30% for the Euro Stoxx 50.

“That’s a big difference,” he said.

“The Euro Stoxx also pays a high dividend yield, but dividends may or may not help. It depends on the structure.”

The dividend yield on the Euro Stoxx 50 is about 3.40%, compared with 1.90% for the U.S. benchmark.

“It helps for the leverage and the upside in that it gives you more to buy calls. But it hurts the puts and therefore doesn’t give you a lot for the downside protection.”

An industry source noted that the two top deals were almost identical except for the underlier.

“It’s interesting,” he said. “I wonder if it’s for the same client.”

Both deals had about the same price and were very similar, observed the sellsider.

“They certainly have the size of wirehouse deals, but there is no indication that it’s for the same client,” he said.

Protection

The market produced more barriers and buffers than average on leveraged notes, according to the data.

There were only four offerings of leveraged return notes without protection. They totaled $7 million, or 2.33% of the volume. The average for the year is over 25% with $4.7 billion sold in 320 deals.

“I don’t know if it’s sentiment-driven or if it’s pricing. It’s always very difficult to tell,” said May.

“Pricing at least is most definitely a factor.

“Volatility is a bit higher than what it was at the same time last year. It’s a plus in terms of getting better caps.

“For the downside, you’re getting better protection, but it’s only percentage-wise.

“You might now get 20% protection versus 15% or 10% last year. But if the market is higher now, you need more.”

Bank of America Corp. priced the top leveraged product and the No. 4 in size with $32.95 million of five-year notes linked to the Dow Jones industrial average. The leverage factor was 1.292. There was a 10% buffer on the downside.

The top agent was Credit Suisse with $56 million sold in eight deals, or 19.57% of the total. It was followed by Deutsche Bank and Wells Fargo.

“People are tired of rolling their one-year, two-year bullet CDs. They need more.” – A sellsider

“I don’t know if it’s sentiment-driven or if it’s pricing.” – Tom May, partner at Catley Lakeman Securities, on the greater use of barriers and buffers in leveraged notes

© 2015 Prospect News.
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