Structured products issuance thin at $255 million for week as stock rally cools off

By Emma Trincal

New York, Feb. 13 – The first week of February was rather slow with agents pricing $255 million of structured products in 100 deals, according to preliminary data compiled by Prospect News.

In contrast, the previous week, which closed January, saw $1.27 billion priced in 476 deals.

This trend is consistent with the monthly calendar. But sources pointed to other factors as well.

“It was light. There was an outing down in Florida. A lot of people were out of the loop,” a structured notes trader said.

“That could explain in part why issuance was down.”

He was referring to a conference held on Thursday and Friday by the Security Traders Association of Florida in Clearwater Beach.

After weeks of a sustained bull trend, the stock market finished flat for the week as investors remain concerned about a set of wildcards such as the trade talks with China and the prospect of a second government shutdown.

Defensive bias

Since the year began up through the beginning of last week, the S&P 500 index soared by nearly 12%.

Since then and even during the rally, structured notes investors appeared to have turned more defensive. Sources said some tend to “sit on the sidelines,” while others prioritize more conservative products.

An example last week was the overwhelming amount of leveraged notes with buffers or barriers accounting for 44% of the total, or $112 million. In sharp contrast, only $4 million worth of leveraged deals with full downside risk hit the market.

Autocallable contingent coupon notes made for only 15% of the flow. On average about 25% of the total volume this year has fallen into this category.

Year-to-date down

More concerning in this early stage of 2019 are signs of a slight slowdown for the year to date as well as the 12-month trailing period.

Sales are down 48% this year through Feb. 8 to $3.96 billion compared to $7.62 billion during the same time in December. Granted, this time in December preceded the severe holiday sell-off. But on the other hand, investors this year have enjoyed a robust relief rally, which should have revived their confidence. Or it may not have.

“Not only structured products are down. The fixed-income market is down in volume as well,” a market participant said.

Plain vanilla space

“Corporate bonds are not seeing a huge volume either. The only thing that’s working are CDs. I’m not even talking about structured CDs. Just plain-vanilla ones.”

Deals were preeminently structured around equity indexes although single-stocks showed some vitality making for 28% of the total notional, which is above average.

“We’re seeing autocallables on stocks. I’ve seen some FANG deals. SocGen did one,” he noted.

The acronym “FANG” stands for “Facebook,” “Apple,” “Netflix” and “Google.”

Other signs

Volume in the 12-month trailing period to Feb. 8 was $53.18 billion, down 2.3% from $54.43 billion in the same period a year earlier, according to the data.

Finally, the spike in the number of offerings, which consistently supported volume last year, is a trend that’s showing some signs of receding.

For the year to date, the number of offerings has dropped 36.5% to 1,153 from 1,816.

On a 12-month trailing basis the count is up 6.2% to 15,517 from 14,612. This of course is a reflection of last year more than an indication of what will come next.

“Do I feel like clients are excited about buying structured notes? No,” the market participant said.

“China is definitely looming. The government shutdown, not so much. But the elections are coming up in two years. For many investors it’s a consideration. They don’t want to look at notes maturing in 2020. It will be an interesting election...interesting primaries. A lot of talking that will impact the market.”

For now, many agree that the impending deadline for the trade negotiation between the United States and China is what really matters for investors.

“Once we get a deal, a lot of the uncertainty will go away. It will be good for the market,” he said.

Pricing is good

The structured notes trader said that investors are overly cautious in an environment where deals have become more attractive.

“The structures getting priced are more appealing,” he said.

“Usually to get a coupon you need the equity component. Now you don’t necessarily need to do that,” he said.

“People talk about an impending recession this year or next year. I don’t see that. We have a strong economy. We have full employment. They released inflation numbers this morning. A 2.2% CPI is not inflation. It’s growth. We haven’t had inflation in years.”

Even more accomodative

The Federal Reserve’s tightening stance at the end of last year led to the December pullback, sources said.

Since the beginning of the year, the Fed has pledged to be “patient,” which helped fuel the stock market rally. This trader went further in his analysis, raising the possibility of a policy reversal with the Fed turning unequivocally dovish.

“I don’t think interest rates are going to be higher. The Fed is on pause. Next, they will be cutting. I wouldn’t be surprised if they did it by the summer.”

Steepeners

For this trader, investors are missing important opportunities.

“It is slow. Part of it is because people have a herd mentality. Everybody got scared in December. Now they’re waiting,” he said.

“Most people are followers, not leaders. Take a look at the steepeners. Coupons are near zero right now. When the curve steepens, coupons will come fast and furious. These are floaters. They don’t act like fixed rate. When your coupon shoots up, what do you think will happen to the price of your bond? It’s a terrific trade.”

He gave the following example: a year ago the Constant Maturity Swap rate spread between the 30-year and the two-year was 50 basis points. A note paying four times the spread now pays 2% in interest.

“If the spread goes from 50 to 200 bps, your coupon will jump from 2% to 8%. Anyone who bought those notes at deep discounts will now own a paper that trades at a huge premium.”

Such bets on a steeper curve are not for everyone. But in the meantime, pricing has also become favorable for more skittish investors, he added.

Vigilant investors

“In rates, people are now demanding a fixed coupon because they don’t want to take the risk of a correction in the stock market and lose the coupon. And they’re getting it. They’re willing to take the risk on principal with a good barrier, not on the coupon,” he said.

Defensive attitudes are also visible in the equity-linked notes space.

“Now people want buffers to protect their principal. You’re seeing more of it because people want the protection,” he said.

Top trades

The top deal last week was a synthetic reverse convertible issued by Wells Fargo Finance LLC.

The $31.71 million of notes due Sept. 28, 2023 linked to Delta Air Lines, Inc. will pay at maturity the greater of par or final parity. The final parity is the share ratio, 14.05538, multiplied by the final stock price on the determination date, Sept. 25, 2023. Wells Fargo Securities, LLC is the agent.

“I’m surprised they’re getting that size for something that’s so specific,” the market participant said.

“It depends on who bought it, I guess. It could be a high-net worth making a specific inquiry. Wells Fargo won the bid, priced it and then they sold it.”

Wells Fargo came up with the second largest deal last week in $23.36 million of buffered leveraged notes tied to the S&P 500 index. The notes will mature on Nov. 25, 2020. The payout will be 1.7 times the upside return up to a 22.61% cap. If the index declines by 12.5% or less, investors will get par. They will lose 1.1429% for every 1% of decline beyond the buffer.

“This note matures just after the presidential elections. Someone must have liked the terms with the volatility. It’s for investors who just feel bullish,” he said.

The next deal was linked to a single stock. It offered a fixed coupon plus a potential bonus in the form of an additional coupon if the underlying hits a higher strike. BofA Merrill Lynch, which has branded those deals as “STEP Income,” was the agent.

Barclays Bank plc priced $14.19 million of two-year 7.5% STEP Income Securities linked to Microsoft Corp. Interest is payable quarterly.

If the final price of Microsoft stock is greater than or equal to the step level, 107.5% of the initial share price, the payout at maturity will be par of $10 plus 4.21%.

If it is above the initial price but below the step level, investors will receive par. Investors will be fully exposed to losses.

Wells Fargo was the top agent last week with $54 million in its two deals, representing 21.2% of the total volume. It was followed by UBS and JPMorgan.

The No. 1 issuer was Barclays Bank plc with 12 deals totaling $48 million.

For the year, JPMorgan Chase Financial Co. LLC leads with 172 offerings totaling $533 million, or 13.5% of total volume.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.