Agents price $453 million; more action seen in Europe with World Bank’s large structured bonds

By Emma Trincal

New York, June 24 – Agents in the U.S. market sold $453 million in the week ended Friday in 117 deals, according to data compiled by Prospect News.

For the month through June 19, volume has fallen by 15.37% to $1.32 billion from $1.56 billion for the same period of May.

However, June’s volume is up 10.8% compared to the $1.19 billion priced in June of last year.

Last week’s action was relatively sluggish for a third week in a calendar month, showing an 18% decline from the $553 million priced the week before.

Meanwhile, global equity markets were on a roll. The Nasdaq and the Russell 2000 hit new record highs in the midst of rally triggered by the Federal Reserve Board stating that it will only gradually raise interest rates.

A sellsider pointed to the bullish sentiment as a factor that can impact volume both in terms of price and investor behavior.

Bull market

“The rally has compressed volatility. It hurts all those notes that sell volatility,” he said.

“We’re also beating records on all major indices. There is this sentiment among investors that we may have a correction, perhaps this summer. Many think that we’re due for a correction.

“These high valuations lead a lot of investors to step aside.”

The volume of leveraged notes with no downside protection was weak last week, accounting for only 4.3% of the volume versus a 25% average market share year to date, according to the data.

“Leverage is affected by volatility as well. Low volatility may cheapen the cost of the call options used to enhance the upside, but the volatility skew presents a problem because you’re using call spreads,” he said.

“The way you buy the calls is by selling the puts. The volatility on the downside is cheaper. When volatility comes down, the put is worth less, so you buy less calls. It deteriorates the amount of call spread, which has an impact on your amount of leverage, protection and cap.”

For the year to date, sales are beating last year’s volume with $22.41 billion issued as of Friday, a 15.13% jump from last year, according to the data.

Green

The World Bank (International Bank for Reconstruction and Development) issued two large structured green bond deals last week. Both were sold to European investors. As a result, those deals are not included in the previously mentioned weekly figures, which only take into account U.S. deals. Yet the pair of green bond offerings caught market participants’ attention for their size and the underlying indexes used in an effort to target investors focusing on socially responsible investing, or SRI, which some see as an upcoming trend in the U.S. structured products market.

The first deal was World Bank’s $83.54 million green bonds linked to the Ethical European Equity index. The eight-year bonds will pay a 1.75% coupon on June 29, 2016 and June 29, 2017. At maturity, investors will receive par plus the annual average return of the underlying index. BNP Paribas was the agent. The proceeds of the green bonds will support financing of environmental projects. The notes were offered to Italian retail investors.

The second World Bank structured green bond, also with an eight-year tenor, priced for $50 million. It was linked to the iStoxx Europe ESG Select 30 index. J.P. Morgan Securities plc was the lead manager. The bonds were offered to institutional investors in Europe.

It was the first use by the World Bank of this index, according to a bank news release.

The term ESG stands for environmental, social and governance.

“So far the World Bank has worked only with BNP for these kinds of structured green bonds. JPMorgan is the only other [agent] for these kinds of deals,” a market participant said.

Since 2008 when it began its green bond program, the World Bank has raised more than $8.5 billion through 100 green bonds in 18 currencies, according to the bank’s website. Nearly all the bonds, however, have been distributed outside of the United States, the market participant noted.

“If you take equity-linked green bonds, there has been only one U.S deal,” he said.

The agent for this deal, which was sold for $29.69 million last month, was BNP Paribas. The green bonds due 2025 were issued by the World Bank and linked to the Ethical European Equity index.

The World Bank so far has been using only two agents for those structured green bonds worldwide – BNP Paribas and now JPMorgan for last week’s $50 million offering.

“There is a lot of interest from other U.S. firms. The World Bank is open” to expanding its U.S. distribution network, the market participant said.

New niche

The sellsider said that SRI investing has not totally caught on yet as a trend among U.S. retail investors.

“I haven’t seen a significant success of those deals in the U.S. yet. We haven’t participated in this trend ourselves. We haven’t launched these types of products,” he said.

One reason for the slow development of the trend in the United States is simply habit.

“The U.S. structured products market is dominated by broad-based indices. It’s always difficult to introduce innovation or new indices. You have to train the sales force, educate clients,” he said.

It doesn’t mean that U.S. investors are averse to sophisticated investments, he explained. But very often, higher levels of complexity are tolerated at the structural level when investors are already familiar with the terms.

“Some products, such as the phoenix autocallables, the so-called boosters with two times on the upside and a cap and one time on the downside, these can be considered complex, but they’ve been around for a very long time,” he said.

Pricing matters

However, the market environment may be favorable to an expansion of volume in delta one index-linked notes including those based on ethical themes, he added.

“We’re still in a low interest rates environment. We’re still in a low volatility environment. It’s difficult to offer notes that give you yield because yield comes from volatility. And it’s also difficult to offer principal protection, which is mostly driven by interest rates,” he said.

“Firms have to come up with a new story. These new indices that have themes, like long/short or ethical investing or research-related ideas, can be attractive because they allow investors to express a specific view or access a particular market.”

Asked whether ethical index-linked notes could gain acceptance in the U.S. market, he said that current conditions suggest that they will.

“The market is still not providing ideal pricing conditions. Interest rates are still low. Eventually they will go up, but it could take another year or even a year and a half before we see a significant rise in interest rates. Meanwhile, theme-based investing as a trend is a way to compensate investors for what they can’t really achieve in pricing.”

Appeal

The market participant said that structured notes linked to SRI strategies may be about to gain momentum because of their broad appeal.

“We’re seeing a greater interest in the U.S. for these products,” he said.

“Structured green bonds especially are popular. Green bonds fund environmentally friendly initiatives. Notes linked to indices like the Ethical European index are appealing to a lot of investors, both retail and institutional investors.

“People also like the principal protection.”

The largest U.S. deal last week was a currency-linked note. Morgan Stanley priced $78.15 million of 0% autocallable currency-linked notes due June 25, 2020 linked to the performance of the dollar relative to the euro.

Wells Fargo & Co. priced the No. 2 deal with $55 million principal amount of 0.25% optionally exchangeable securities due June 24, 2022 exchangeable for the class P common stock of Kinder Morgan, Inc.

Morgan Stanley was the top agent, pricing six deals totaling $134 million, or 29.66% of the total. It was followed by JPMorgan and Barclays.

“The rally has compressed volatility. It hurts all those notes that sell volatility.” – A sellsider

“We’re seeing a greater interest in the U.S. for these products.” – A market participant on notes linked to SRI strategies

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