Worst-of deals continue to dominate the market amid renewed geopolitical tensions, sell-off

By Emma Trincal

New York, Aug. 16 – The summer, usually slow for U.S. equity markets and structured notes issuance, did not show signs of lethargy last week as global equities fell for two days under geopolitical tensions after recovering on Friday.

After legitimate concerns due to increased tensions between the U.S. and North Korea and the ensuing profit-taking, the bulls had the last word.

Stocks pulled back on Wednesday after president Donald Trump threatened North Korea with “fire and fury.”

On Thursday the sell-off intensified. The Dow Jones industrial average fell 200 points amid escalating tensions between the two countries, its biggest drop since May. Some analysts argued that the pullback was overdue given the prior 10 winning sessions of the Dow with new record highs and a market many consider richly valued.

Despite recovering some of its losses on Friday, the S&P 500 index finished the week down 1.4%.

VIX spike

Volatility rising may have helped the pricing of some deals.

The CBOE Volatility index hit a three-month high to 15.50 on Wednesday.

When volatility rises the selling of options provides higher premium, which can improve some of the terms.

But a sellsider was skeptical.

“Given the timing in the middle of a very slow month... It was so short-lived...it happened and went away. I don’t think it affected the volume a whole lot,” he said.

“Perhaps some deals did not price and would have priced otherwise. But I don’t think it changed the average trend.”

Year

Exceptionally, Prospect News’ volume data for last week was not available at press time on Wednesday.

But for the year, sales of U.S. structured notes are up 43% through July 31 to $30.59 billion from $21.39 billion last year, according to available data compiled by Prospect News. The number of offerings has grown by two-thirds to 7,914 from 4,788 during that time.

“Things look good right now, even for a summer. I’m pretty optimistic,” the sellsider said.

“If the equity markets get hit, if North-Korea escalates it might be different. But we’re having a good year so far. Let’s hope it finishes that way.”

July shining

Last month was the best month of July in a decade, since Prospect News began to track all structured notes’ asset classes. It is likely to have been the best ever as well based on separate asset classes data.

“We’re seeing a lot of volume. We’re definitely growing. We’re busier than usual for this time of the year,” the sellsider added.

“You still have equities moving up; that always helps.”

A look at some of the deals which priced last week showed the unchanged pattern: investors continue to heavily bid on worst-of products while issuers are getting more creative to meet demand.

“I wish there would be a better name than worst-of. Some call them the lesser of. It’s not great marketing. But the truth is those structures offer very attractive terms,” said a market participant.

Theme deals

Worst-of linked to stocks of the same sector reflect the appeal of theme investing. Some sectors emerge as more popular such as finance, oil and technology.

Barclays Bank plc for instance priced a small deal of two-year phoenix autocallable notes linked to the least performing of three credit card stocks – Visa Inc., Mastercard Inc. and American Express Co.

The bank will also price this Wednesday another phoenix autocallable “financial” deal. The three-year notes will be linked to three bank stocks – Bank of America Corp., JPMorgan Chase & Co. and Wells Fargo & Co. The notes were set to price this Wednesday.

“Given the environment, with rates positioned to continue to slowly rise, bank stocks are popular. People want to play the financial theme,” the sellsider said.

Worst-of on benchmarks

The majority of the worst-of are autocallable contingent coupon notes. Primarily the underliers are two indexes.

“There’s a lot of volatility in the market for certain names, and you see very attractive pair profiles,” said the market participant.

Some issuers extend the maturity in order to avoid adding too much volatility in the underlying as well as to lower barriers.

GS Finance Corp. showed $10.75 million of 10-year trigger autocallable contingent yield notes linked to the Russell 2000 index and the Euro Stoxx 50 index. The annual contingent coupon was 7.5%, the coupon barrier, 70%, the final barrier 50%. The notes are not callable during the first year.

“It’s hard to get a big coupon on a single underlier. What the market is doing right now is playing correlation to get a little bump,” said the sellsider.

Single asset deals

Deals for income tied to a single underlier have become rare, even on a contingency basis.

One exception was Credit Suisse AG’s $11.34 million of three-year autocallable contingent securities linked to United States Steel Corp. stock. The annual contingent coupon was 11.7% based on a 50% coupon barrier observed quarterly. The barrier level at maturity was the same. Morgan Stanley distributed the notes.

But this deal was facilitated by volatility. The implied volatility of this stock is 44.5.

Another example of contingent coupon deal tied to a single asset was another Credit Suisse autocallable contingent coupon linked to the SPDR S&P Biotech exchange-traded fund sized at half a million dollars. The yield was 10%, the coupon and final barrier, 70%. It was a one-year note with a six-month no-call. J.P. Morgan Securities LLC is the agent.

Step-up

Autocallable market-linked step ups with long duration also extract premium for contingent coupons. HSBC USA Inc.’s $7.17 million five-year deal, also linked to a single asset, the Russell 2000 index, brought a 6.2% call premium above initial price on an annual observation date.

If the index finishes above the step-up level – 135% of the initial level – the payout at maturity will be par of $10 plus the index gain.

If the index gains by up to the step-up level, the payout will be par plus the step-up payment of 35%. There was a 15% buffer. BofA Merrill Lynch is the agent.

Two plus one

Occasionally issuers employ three underliers for their worst-of structures. It may even become more of a trend, some sellsiders say.

“We definitely see some of those worst-of with three indices. The most common stuff is to throw the Euro Stoxx in there plus a small-cap and a large-cap whether it’s the S&P and the Dow,” said the sellsider.

JPMorgan Chase Financial Co. LLC used the Russell 2000 index, the S&P 500 index and the iShares MSCI Emerging Markets ETF for its $1.83 million four-year autocallable contingent interest notes linked to the least performing of the three. The coupon rate was 7.9%, the coupon barrier 70% and the trigger level at the end, 60%. The notes paid the coupon monthly. The autocall was observed monthly as well.

“Investors’ appetite for those products has been driving some creative structures with two, three and sometimes four underlying,” the market participant said.

Growth too

Less often seen are worst-of participation notes, which are built for return enhancement, not income.

JPMorgan Chase Financial Co. LLC again showed such a deal with five-year uncapped leveraged buffered notes linked to the lesser performing of the S&P 500 index and the Russell 2000 index.

The leverage factor is 1.8 times. If either index falls but by no more than the 40% buffer, the payout will be par. Otherwise, the exposure is to the worse performing index.

“There’s no reason why not to use the same correlation play to give investors leveraged upside,” he said.

“Instead of getting a coupon, you get some growth.”

DOL respite

A key regulatory event for the industry last week was the Department of Labor announcement on Wednesday that it had taken steps to extend the implementation date of the fiduciary rule an extra 18 months from Jan. 1, 2018 to July 1, 2019.

Several sellsiders have said that fiduciary requirements would have a negative impact on brokerage retirement accounts and therefore may slow sales.

“I think it’s a good thing. It was not enough time to have an internal compliance system in place for many firms,” said the sellsider.

“A lot of people were not ready to go.

“The extension gives firms the time they need to get ready.”

“We’re busier than usual for this time of the year.” – A sellsider

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