Structured products issuance slow at $57 million for week as investors digest December chaos

By Emma Trincal

New York, Jan. 9 – After a holiday that was more of a rout than a Christmas rally, it’s no wonder the year kicked off at a sluggish pace last week. With the New Year falling on a Tuesday, many were not yet back to the office or trading desk, especially those advisers working through the holidays to answer anxious clients’ calls inquiring about their portfolios during the previous week, sellsiders said.

Structured products agents priced $57 million in the shortened week ended Friday in just 37 offerings, according to preliminary data compiled by Prospect News.

The previous week, which saw the close of the calendar, recorded $684 million in the sale of 288 offerings.

With $3.27 billion, December was last year’s worst month for issuance volume.

No Santa

December was also a tumultuous month for the stock market as the S&P 500 index fell by 9%, its worst performance since 1931.

Last year started on a strong January interrupted by a sharp correction and followed by a long rally through the summer. At the end though, the benchmark shed more than 6% for the year, courtesy of a fourth-quarter sell-off, which at times, especially on Christmas Eve, turned temporarily into a bear market.

“I think people were caught off guard during the holidays. Everyone was expecting the traditional Santa Claus rally and we just had a painful sell-off instead,” said Matt Rosenberg, sales trader at Halo Investing.

But he said the downturn had been positive for structured notes sales.

“I didn’t see any panic, really. People took a more proactive approach to the repositioning of their portfolio. Instead of just rebalancing and tax-loss harvesting they picked structured notes as a good alternative to stocks because of the optionality they provide.”

Volatility

Last week underwent wild swings again but the roller-coaster ended happily this time.

On Thursday, the Dow Jones industrial average dropped 660 points as negative news from Apple brought down the overall mood. But a buoyant jobs report on Friday along with more dovish comments from Federal Reserve chairman Jerome Powell propelled the Dow 700 points higher.

A sellsider pointed to the difficulty for investors to navigate the constant up-and-down of the market.

“What’s so disconcerting is that the usual inverse correlation between volatility and market gains is no longer respected,” he said.

“Typically, when the VIX goes up, the S&P goes down and vice-versa.

“But in the last couple of weeks, when the market is up, volatility is up as well.”

Structured notes are priced on options whose premiums depend on implied volatility. The change in the relationship between the market and volatility may add to the difficulty of selling and manufacturing deals, he explained.

The correlation between the equity markets and volatility is usually in the neighborhood of 80%, he said.

“This means that 20% of the time, volatility will skyrocket in a rally. This is where we’re at now and people are not used to that,” he said.

Mood swings

The Fed’s shrinking its balance sheet and hiking rates, inflation fears, concerns over trade negotiations, the aging of the longest bull market in history, all those factors weigh on investors’ minds.

But when it comes to sudden volatility spikes, this sellsider pointed to a more tangible factor.

“I’d rather see a calmer market. But our president is not exactly sending calming signals to the market right now. Every day is a new controversy,” he said.

“If something is working, something else has to go wrong. It’s distracting for investors to say the least.”

This sellsider said his criticism did not point to the president’s political agenda.

“It’s not about his policies. It’s about the unpredictability of his next move.

“In a normal market, investors need to know what the Fed is doing. We’re at a point where we need to know what the president is doing. But who can predict that? That’s why we’re in this constant roller-coaster.”

During the year-end sell-off some issuers modified the terms of their deals at pricing or chose the best end of an announced range for caps and barriers.

“This is normal when volatility goes up. First you need to give investors something compelling because they get cold feet,” he said.

“Investors are not dumb. They know that you need more downside protection when risk is higher.

“More risk in the market means that you need to be more conservative on your trade.

“Issuers know that. They optimize the terms when they can.”

Protection, indexes

For structures, last week saw two-thirds of the volume coming from leveraged notes with barriers or buffers. Averaging less than a quarter of total sales, this percentage was unusually high.

Reflecting the same type of risk-aversion, single-stocks made for only 13% of the total versus 84% in equity indexes. The annual average is 16% and 68%, respectively.

The top deal last week was a leveraged buffered structure. JPMorgan Chase Financial Co. LLC priced $13.89 million of one-year notes linked to the S&P 500 index with two-times on the upside up to a 13.6% cap and a 10% geared buffer on the downside.

Interest for downside protection whether through barriers or buffers is growing, noted Rosenberg.

But he does not think buffers are necessarily more in demand than barriers although their pricing has been facilitated by the uptick in volatility.

“There are still people who prefer a deep barrier of, let’s say 30% to 40%, to a 10% or 15% buffer,” he said regarding growth products.

“For autocalls, barriers remain the norm. Terms aren’t compelling enough to do buffers.”

On the other hand, he noticed a variety of traditionally barrier-based structures which have incorporated hard protection.

“I’ve seen some products, for instance digitals or dual directional notes with buffers while it’s almost always done with barriers,” he said, adding that it was still an anecdotic observation, not a trend.

Stock trades

Rosenberg said that last week’s low bid on single-stocks was probably an anomaly.

“There are a lot of opportunities around single names as a result of last month’s sell-off. People are interested in oversold stocks with sound fundamentals,” he said.

An example was Apple. In the last two months, the stock has lost almost a third of its value. The bleeding came into focus again last week when the company lowered its first-quarter fiscal revenue guidance on concerns over global demand for its iPhones, pushing down the share price 10% on Thursday.

It was the day two issuers chose to strike small deals.

Royal Bank of Canada priced $3.56 million of three-year autocallable contingent coupon barrier notes linked to the battered stock. The quarterly contingent coupon annual rate is 9.55% based on a 70% coupon barrier.

After six months, the notes will be automatically called on a quarterly basis if the stock rises above its initial price. The principal repayment barrier at maturity is 70%.

“It’s not just Apple that you’ll see in autocalls. Many good tech names are going to be seen as well because they’ve been hit so hard. The rise in volatility lets you structure a compelling downside protection with a good payoff.”

Domestic tilt

Issuers continued to offer worst-of deals. Those were linked to equity indexes often tied to the S&P 500 index and Russell 2000 index. Last week’s deals however were less than $2 million in size.

GS Finance Corp. and Barclays Bank plc priced autocallable worst-of notes on those two indexes while Toronto-Dominion Bank used the same pair of underliers in a leveraged barrier notes offering.

“Worst-of continue to be popular, but now people are trying to eliminate the Euro Stoxx component,” noted Rosenberg.

“With global uncertainty, trade wars, investors are more focused on what they know.

“Structures that carry cross-Atlantic exposure don’t have the same risk profile as something more U.S.-centric.”

The higher volatility also allows issuers to use more correlated indexes, such as U.S. benchmarks transferring the risk premium from dispersion to implied volatility.

“You don’t need the Euro Stoxx that much anymore. I see a lot of S&P and Russell. Sometimes, people even add the Dow,” he said.

Last week’s top agent was JPMorgan with $19 million in four deals. It was followed by Goldman Sachs and Morgan Stanley.

JPMorgan Chase Financial Co. LLC was the leading agent.

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