Structured products market confronted with small deals, low volume; bid for protection is high

By Emma Trincal

New York, May 18 – Mixed economic data and flattish equity markets translated into lackluster issuance volume for structured products, though May figures were an improvement from April’s. Investors in this market are gravitating toward notes that offer some level of downside protection.

Volume trends

Agents in the second week of May sold much less in volume than in the previous week, according to data compiled by Prospect News. Pricing amounted to $187 million. It was more than half the $384 volume seen when the month kicked off.

The number of deals was weak as well during the week ended Friday: 64 offerings versus 76 the week before.

Finally none of the deals that priced last week exceeded $25 million in size, an unusually low threshold.

The year-to-date volume continued to be lower. Agents priced $13.43 billion, down 25% from last year’s $17.85 billion as of May 13.

Surprisingly, however, May’s volume is showing an improving trend. At $591 million, it rose by 54% compared to April, which saw the pricing of $384 million only. Those figures though represent the first two weeks of each month.

Compared to last year, volume is down in May almost 40% from $932 million.

Headwinds

Overall, the picture is not a rosy one, market participants said.

“It’s very hard to nail down the nature of the problem,” said a sellsider.

“It’s a combination of optical trades that are in the market...that are not very exciting and also the transition into new issuers.”

He was referring to banks’ recent moves to issue structured notes out of one of their subsidiaries in order to comply with the so-called Total Loss-Absorbing Capacity requirements, also known as TLAC.

“I don’t think it has affected demand for notes. But it has created noise in the system. Plus you have a whole bunch of other stuff going on while flows are low.

“Bottom line: optics aren’t looking as good because interest rates are low and volatility is not that high.”

Protection quest

The industry however is adapting to the new market conditions characterized by a directionless market and flat equity returns, a structurer said.

“I think the major theme right now is less upside and more protection,” he noted.

“People don’t expect high double-digit returns anymore. But they want more protection on the downside.”

The weekly data confirmed his analysis. About 70% of the volume priced last week consisted in deals that included either a buffer or a barrier. Protection amounts (on a contingency basis or not) ranged from 5% to 50%. A total of 51 deals amounting to $130.50 million fell into this category.

There were no fully principal-protected notes offering last week. This is consistent with a declining trend as full capital guarantee has become too hard to price in a low interest rate environment. For the year, those fully protected notes accounted for only 1.6% of the total volume.

Autocalls

For last week, autocallable reverse convertibles continued to see a strong bid. Those structures amounted to $66 million, or 35% of the total, exceeding in volume leveraged return notes, which is unusual. Leveraged deals totaled $48 million, or 26% of the volume.

“We see a lot of this autocall stuff because people are doing macro trades right now,” the sellsider said.

Most of those deals are linked to one or several equity benchmarks, he said.

“We see fewer stock deals. It’s hard to say why. Until the end of last year you saw a lot of people being hurt. We had a rally recently but the market didn’t come back quite as robust.”

While single-stock deals were seen last week, the yearly average only represents 8% of the total this year versus 19% last year. In volume, sales of single-stock-linked notes fell by two-thirds to $1.08 billion from $3.32 billion.

Small sizes

Deal sizes last week were exceptionally small. Only four offerings in excess of $10 million priced and the range was capped at $25 million.

“It’s the middle of the month,” the structurer said.

“But the environment does seem to be a little lackluster. It seems like there is no urgency to take a direction or a view. It is surprising. However, I think it’s temporary unless we see more evidence that this is going to be the trend this year.”

Top deal

GS Finance Corp.’s $25 million of three-month delta one notes linked to the Topix index was the top transaction. It was a repeat deal after an initial $50 million of the notes priced on May 6. The notes were guaranteed by Goldman Sachs Group, Inc. GS Finance is the issuing subsidiary of the bank holding company. The issue price for the upsize notes was 101.27%. The fee was 0.29%.

“I think it’s probably a way to get efficient access to the Japanese equity market. I don’t think there is any [exchange-traded fund] on the Topix, at least not in the U.S.,” the structurer said.

“It could be some kind of Goldman call but it’s unlikely. I think they would have put a little bit of structure around it if they had some conviction, some leverage for instance, not a delta one.

“With 29 basis points in fee, it’s not retail. I guess it’s some kind of building block for some institution.”

Digital

The No. 2 offering was JPMorgan Chase Financial Co. LLC’s $13.03 million of 13-month digital notes linked to the S&P 500 index. JPMorgan Chase Financial Co. is a subsidiary of JPMorgan.

JPMorgan Chase & Co. guarantees the notes.

If the final index level was greater than or equal to the initial index level, the payout at maturity would be par plus 8.25%. If the index declined by up to 10%, the payout would be par. Otherwise, investors would lose 1% for every 1% that the index may decline beyond 10%.

“This one has a term a little bit longer to get the benefit of long-term capital tax treatment. It’s probably a retail deal,” said the structurer.

“In today’s market, the S&P is pretty much flat. A 10% buffer is attractive and getting 8.5% for the equity market doing almost nothing seems also attractive.

Digital notes, absolute return structures and autocallables with contingent coupon are the flavor of the structured note supply in this market environment, he noted. One reason for that is investors’ lower expectations.

“I don’t think people are looking for double digits. I think limiting the upside is getting to be more and more acceptable,” he said.

Worst-of

JPMorgan Chase Financial priced the following deal. It was $11.87 million of two-year contingent income callable notes linked to the worst performing of the Euro Stoxx 50 index, the Russell 2000 index and the S&P 500 index.

The observation was quarterly. The annual rate for the contingent coupon was 10.35%. The coupon barrier was 60% of the initial price. The 60% threshold also constituted the final barrier at maturity. The notes were callable at par on any observation date.

The top agent last week was JPMorgan with 21 deals totaling $74 million, or 39.60% of the total. It was followed by Goldman Sachs and Barclays.

“People don’t expect high double-digit returns anymore. But they want more protection on the downside.” – A structurer

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