Structured products issuance rather sluggish at $172 million for week despite stock market rally

By Emma Trincal

New York, Jan. 23 – The stock market finished up for a second week, but structured notes sales did not quite follow. Agents priced $172 million of structured notes in 72 deals in the week ended Friday.

Issuance volume was down two-thirds from the previous week that saw the pricing of $454 million, according to data compiled by Prospect News. Last week’s figures are preliminary and subject to upward revisions.

Big banks earnings

One quick explanation could be that banks reported their earnings for the fourth quarter last week, including Citigroup, JPMorgan, Goldman Sachs, Bank of America and Morgan Stanley.

“May be the quiet period the day before and the day of earnings could have put the brakes on pricing,” a market participant said.

“They can still have deals in the market but they can’t price them during that time.”

“This could very well be a factor.”

But it probably is not the only one.

Gloomy outlook

“I expect sales of structured products to be pretty tepid in January,” he added.

“Anybody predisposed to be afraid should not be watching the news. It’s unbelievably gloomy. From reports of a slowing Chinese economy, to the ongoing U.S.-Chinese trade talks, this endless government shutdown, Brexit... there is a lot of uncertainty out there, a lot of reasons to be concerned.”

Meanwhile in equities, the Dow Jones industrial average jumped 3% while the S&P 500 index rose 2.9% last week.

A news report suggesting that U.S.-Chinese trade talks were improving along with a good start in the earnings season contributed to the uptrend.

January supply eyed

Yet structured products issuance figures are lukewarm.

For the month through Jan. 18, agents sold $832 million of structured products compared to $1.12 billion during the same time in December, a 26% decline.

This short two-week stretch compared to a year ago reveals a 44% drop from $1.49 billion.

To be sure, during the first half of January last year, the market was going through a euphoric “tax cuts” rally. In addition, very large synthetic convertible deals priced at the same time, making the period hard to match.

But the contrast with the first two weeks of December, which was the weakest month of 2018, was more of a concern, especially given the nearly opposite market conditions between now and then.

During the first 18 days of last month, the S&P 500 index flirted with correction territory. This year it has gained close to 7%.

Market sentiment

For some the explanation is to be found in psychology.

“Advisors loath to commit clients’ money when there is so much uncertainty,” the market participant said.

“People went came back from their holiday petrified by the sell-off, and they’re still hesitant.

“We had a rally last week, but the market is still all over the board. A lot of the buying was just technical. It could be market timing. Meanwhile stocks have been trading down this week.”

Market sentiment does not always immediately reflect price action in the market, especially when stock prices keep on going up and down as volatility increases.

One good indicator of investors’ intentions is to look at flows of money in and out of exchange-traded funds and mutual funds, this market participant said.

“It would be interesting to follow the flows of money for ETFs and mutual funds. I bet the percentage changes are comparable to what we see with structured products. ETFs are more of an institutional market while mutual funds are mostly retail. But I’m guessing that they can capture the general market discomfort we see not only with structured products but with just about everything.”

Income, leverage

The most popular structures last week were autocallables, making for 38% of the total versus 30% for leverage.

Within the leverage category, the overwhelming majority featured barriers or buffers.

“How do you maintain your exposure to the market while adding some protection? They invented buffered notes exactly for that. You’d think we would see more of these in this environment,” the market participant said.

On the autocallable front, the bulk of volume consisted of contingent coupon deals rather than pure autocalls that pay a call premium rather than a coupon.

Worst-of deals

Worst-of deals continued to be in favor, accounting for $46.25 million in 20 deals, or 27% of total issuance volume.

Those structures remained heavily based on indexes with only a minority of stock deals seen in small deals under $1 million, the data showed.

Euro Stoxx 50 exit

One notable change compared to one or two months ago is a trend toward more U.S.-centric worst-of deals.

The Euro Stoxx 50 index vanished from the list of worst-of underliers and was replaced instead by a U.S. benchmark. The most common combination of underlying indexes in last week’s worst-of deals were the S&P 500 and Russell 2000 and less frequently, the same pair with the Nasdaq Composite.

The trend may just be related to pricing. If the correlation between the U.S. indexes and the euro zone benchmark increase, the risk premium will diminish making the terms less appealing.

“My guess is that correlations may have changed and it could be dragging down the coupon,” the market participant said.

“Investors have been buying notes on the Euro Stoxx when they could get attractive double-digit coupon,” he said.

Despite the pricing advantage of the Euro Stoxx 50 associated with its high dividend yield, investors tend to have lower allocations to European stocks, he noted.

“U.S. investors like to invest in what they know and when they seek European exposure, they tend to go for the EAFE, which is more broadly diversified across other regions,” he said.

The top deal last week consisted of contingent coupon autocallables on a single asset.

Top deal

Barclays Bank plc priced $14.37 million of three-year notes linked to the Dow Jones industrial average.

The notes will pay a contingent quarterly coupon at an annual rate of 8% if the underlying index closes at or above the 75% downside threshold on the determination date for that quarter.

The notes will be called at par plus the contingent coupon above initial price. The principal repayment barrier at maturity is also at 75%.

Two Morgan Stanley deals

The second deal from the same issuer was $12.13 million of two-and-a-half year leveraged notes on the S&P 500 index. The notes are distributed by Morgan Stanley Wealth Management. The payout at maturity will be plus double any index gain, up to a 29.5% cap.

Investors will receive par if the index falls by up to 10% and will lose 1% for each 1% decline beyond the buffer.

Morgan Stanley also distributed the next deal: UBS AG, London Branch’s $11.57 million of one-year contingent income autocallable notes linked to the S&P 500 index.

The contingent coupon payable quarterly is 8.5% per year based on an 80% coupon barrier.

The notes will be called at par if the index closes at or above its initial level on any quarterly determination date.

A soft protection of 20% applies at maturity.

Commodities notes are showing signs of a moderate pick up. An example was the No. 4 deal brought to market by Morgan Stanley’s issuing unit.

Commodity play

Morgan Stanley Finance LLC priced $10.28 million of 0% buffered digital notes due Feb. 19, 2020 linked to the S&P GSCI Crude Oil Index – Excess Return. This deal used an increasingly popular structure: digital payouts that kick in above a barrier situated below the initial price, which allows investors to strongly outperform a long position on the downside.

In this case, if the index is greater than 85%, investors will receive a digital payout of 18.5%. Otherwise they will lose 1.1765% for each 1% that the index declines beyond 15%.

A small deal with an exotic structure came out from Wells Fargo in the form of a note combining a discretionary call with an automatic call. Sources said the exotic feature was not common.

Call and autocall

Wells Fargo Finance LLC priced $5.9 million of 18-month notes linked to the lesser performing of the Russell 2000 index and the S&P 500 index.

On July 17, 2019, the notes are optionally callable at 105.05% of par. On Jan. 22, 2020, the notes will be automatically called at 110.1% of par if the lesser-performing index closes at or above its initial level.

If the notes are not called and the lesser-performing index finishes at or above its initial level, the payout at maturity will be par plus 15.15%. If the lesser-performing index finishes below its initial level but at or above its threshold level, 80% of its initial level, the payout will be par plus 9%. Below the 80% level, investors will lose for each point of decline in the lesser-performing index 1.25 times in return.

“It’s unusual to have a call and an autocall in the same structure,” the market participant said.

“But they are doing that for a reason. It’s probably pricing.”

A structurer explained the possible rationale.

“Issuer call is favorable to the issuer while the autocall is relatively neutral. So, if the structure is issuer-callable on an earlier date and then switches to an autocall, the pricing should be a little bit of both: the terms will be more favorable than a regular autocall but still not as favorable as a regular issuer call.”

Marketing this type of note could be challenging given that some investors, especially on the fee-based space, tend to avoid discretionary calls, he added.

“Maybe the issuer’s rationale is that investors may tolerate the issuer call feature for a short time.”

The top agent last week was Morgan Stanley with $52 million in nine deals, or 30.2% of the total. It was followed by UBS and JPMorgan.

The No. 1 issuer last week was Barclays Bank plc with seven offerings totaling $36 million, a 21.15% share.

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