Structured products issuance $303 million for week; leverage, single-stock deals decline

By Emma Trincal

New York, Aug. 14 – Agents priced $303 million of structured products in 113 deals in the week ended Friday, according to preliminary data compiled by Prospect News. While the start of a new month tends to be slow in structured products action, the week turned out to be one of the most volatile of the year for the equity markets.

Simultaneously, the volume of leveraged return notes and single-stock-linked notes fell below average.

The market roller coaster began right on Monday with the biggest point loss of the year as the Dow Jones industrial average dropped 727 points, reacting to China devaluating its currency, a response to president Donald Trump’s new tariff threats. The VIX, which has been below the 20 mark most of the year, surged to 24.59 on that day. A rally followed mid-week once China backed off, but tension flared again on Friday when Trump suggested that a meeting with China in September was not a done deal.

Revised data for the closing week of July (ending Aug. 2) showed a notional of $1.15 billion in sales. It remained below the best closing weeks of the year in March, April and May, when volume exceeded $2 billion.

Leverage crushed

A few peculiar trends could be spotted last week.

To begin with, leverage was at record low levels. Leveraged return deals with barriers or buffers accounted for $31 million, a meager 10% of the total compared to a year-to-date average of about 25%. Perhaps more understandable given the rising volatility was the market share of unprotected leverage down to 1% of the total versus a 12% yearly average.

For some, low interest rates were the main culprit.

“In order to create leverage with buffers, you need to have some yield. These are not principal-protected notes which require even higher interest rates. But still, you need a reasonable amount of yield, which you don’t have,” a distributor said.

To be sure, the fear of negative interest rates coming to the U.S. contributed to last week’s volatility.

With three central banks cutting their interest rates last week (New-Zealand, India and Thailand) and rising concerns over growth, demand for the 10-year Treasury increased, pushing its yield down to 1.65%, not so far from its record low of 1.37% in 2016.

The narrowing spread between the two-year and the 10-year revived fears over an economic slowdown as an inversion of this part of the yield curve is seen as a recession signal. Investors’ angst about an inverted yield curve turned into reality Wednesday morning.

A second reason behind the scarcity of leverage plays last week was simply a reflection of investors’ outlook.

“When you buy leverage, you’re betting on the upside. You have to expect that the market will continue to go up,” the distributor said.

“It’s harder to remain bullish when the market is still near its all-time high and with tweets that come out from the president.

“People hope for moderate returns, but a growing number of investors expect the market to drop.”

Search for yield

Conversely income-oriented notes made for $190 million, just about two-thirds of the total weekly volume, which is unusually high compared to the year-to-date average at about a third. Those income notes were nearly all autocallable contingent coupon deals and to a lesser amount snowball autocalls, which pay a call premium rather than a coupon.

This continued bid for income may have two causes, the distributor said. On the one hand, lower yields are making the search for income an absolute necessity for retirees. On the other, a market at all-time highs may predispose investors for a target return in the form of a coupon since return expectations are limited. In addition, the often-deep barriers and the autocall itself are perceived as risk mitigators.

Worst-of, all on indexes

As it has been the case this year, worst-of deals constituted the bulk of income notes. A total of $163.3 million fell into that group last week in 30 offerings. Volume wise, worst-of deals accounted for 54% of total issuance volume and 86% of all income deals.

Worst-of have been sold as a way to juice up yield in a low volatility environment. As volatility has been ramping up in August, their stronger-than-ever supply may come as a surprise.

Not for the distributor, who said: “They create such benefits. You can enhance yields by points.”

Another unusual situation: there were no worst-of on single stocks last week. Equity indexes were overwhelmingly dominant, excluding single stocks but also exchange-traded funds. Only the iShares MSCI Emerging Markets ETF was spotted in addition to a U.S. equity benchmark.

“It’s probably not a durable trend,” the distributor said, who sells worst-of deals on stocks.

“We’ve been very successful in pricing deals with six stocks. We used the FANG and added Microsoft and Apple. Those are worst-of, but you get a high correlation. You can generate 20% coupons with comfortable barrier levels.”

Year, summer

Issuance volume for the year to date is not improving at a fast clip. In fact, the decline persists with $28.26 billion through Aug. 9 from $36.04 billion last year, a 21.6% drop.

“Between the trade war, the slower growth, the yield curve inversion, across the board, what we’re seeing is a buyside that’s spooked. And when you’re spooked you stay on the sidelines,” said the distributor.

“I think that’s what it boils down to.

“The appetite for equity has been reduced.”

A market participant was more optimistic.

“People are fearful about the future. But August has never been a good month for the market to begin with. I suspect volatility will remain high throughout the end of the month,” he said.

The sluggish activity during the summer was a factor behind the lackluster volume.

“It doesn’t help that most people are on vacations. Many advisers don’t have discretion over their clients’ accounts. They run a few things by them before they leave. After that nothing much happens.

“Same thing on the sellside...Trading desks are empty.

“So, I think we’ll see an uptick in September.”

The tally for this summer from June 1 through Aug. 9 is showing a decline of only 8.3% to $8.24 billion in 2019 from $9 billion, the data showed.

Top deals

Last week’s top deal was designed to navigate a possible downturn via a dual directional payout.

Morgan Stanley Finance LLC priced $20 million of 3˝-year trigger participation securities linked to the S&P 500 index. On the upside, the 100% participation rate is capped at 26%.

If the index declines by 30% or less, the payout will be par plus the absolute value of the index return.

Below that, investors will be exposed to the index decline from its initial level.

If the index declines by more than 30%, investors will lose 1% for every 1% that the index declines from its initial level.

UBS AG, London Branch’s $19.81 million of two-year autocallable notes linked to the S&P 500 index was the second deal in size. Each quarter, the notes will pay a contingent coupon at the rate of 7% per year if the index closes at or above the downside threshold level, 78.5% of the initial level.

After six months, the notes will be automatically called above initial price on any quarterly observation date.

The repayment barrier is also 78.5% at maturity.

Worst-of, callable, American

HSBC USA Inc. priced the next largest deal with $19.49 million of 3˝-year callable contingent coupon notes.

The payout is based on the least performing of the Nasdaq-100 index, the Russell 2000 index and the S&P 500 index. The quarterly contingent coupon is at 10.55% per year but the observation is daily, based on a so-called American barrier of 70%. The issuer may call the notes on any quarterly observation. The repayment barrier at maturity is set at 60% of the initial price and observed point to point.

UBS Financial Services Inc. and HSBC Securities (USA) Inc. are the underwriters.

The top agent last week was UBS with $118 million in 60 deals, or 38.84% of the total. It was followed by Citigroup and Morgan Stanley.

HSBC USA Inc. was the No. 1 issuer with $57 million in seven offerings, an 18.93% share.

Barclays Bank plc leads for the year to date having brought to market 1,063 deals totaling $4.25 billion, a 15% share.

“It’s harder to remain bullish when the market is still near its all-time high and with tweets that come out from the president. People hope for moderate returns, but a growing number of investors expect the market to drop.” – A distributor

“People are fearful about the future. But August has never been a good month for the market to begin with. I suspect volatility will remain high throughout the end of the month.” – A market participant

© 2015 Prospect News.
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