Agents price $511 million of structured notes for week; huge influx of income notes seen

By Emma Trincal

New York, Jan. 15 – Total sales of structured notes in the week ended Friday amounted to $511 million, a healthy notional size for the first full week of the year. The tally for deals was 160, according to preliminary data compiled by Prospect News.

Last week was pivotal for the market as it saw the bulls regaining control after a short pause the week before due to the killing of Iranian general Qasem Soleimani by the U.S. military on Jan. 3.

The S&P 500 index rose 0.9% last week, hitting an intraday high on Friday at 3,283.

The market reacted positively to the reduced tensions between the United States and Iran, resuming a solid rally, which began in the fall.

On Friday the Dow Jones industrial average rose above 29,000 for the first time ever. But the rally ended the same day with a jobs report below expectations.

Income mania

Last week’s notional presented an overwhelming amount of income products along with a notable reduced share of leveraged products. There were $369 million of autocallable contingent coupon notes, also known as “Phoenix autocalls,” and $73 million of pure autocalls, often designated as “snowballs” as they only pay upon the call event but offer a cumulative premium, called “memory.”

Overall, the market shares for income-generating notes was unusually high at 86% of the total.

The first category of autocalls is a better match for pure income-seekers, said a sellsider.

“With the Phoenix, you tend to get a lower coupon because you can get paid while still holding the notes. The deal doesn’t stop,” he explained.

“Also, you usually get paid at the coupon barrier level below initial price. So, it’s easier to get paid. It comes at a price. You have a lower coupon. But people like it for the income.”

Leverage declining

In comparison, leveraged notes made for only 7% of the total with $34 million in 13 offerings.

“Without being overly bearish, people are increasingly thinking of the downside risk. Income products have a cushion, a barrier. People are buying these autocalls because they’d rather have income. They don’t think the market is going to continue to go up that much,” said the sellsider.

“When we are at all-time highs what do you expect? Investors tend to be more neutral and slightly bearish.”

2019 was OK

Most recent updates for last year’s volume showed a 7% decline to $52.78 billion in 2019 from $56.77 billion in 2018.

“I was expecting last year’s volume to be much lower than that. It really came back in the last quarter,” the sellsider said.

Volume year to date in early October was indeed down 20% from the previous year.

“Hopefully, this year will be strong,” he said.

The year is up to a good start. Volume through Jan. 10 is at $630 million, a 32.1% increase from $477 million a year ago. Agents have priced 215 deals for the period versus 143 a year ago.

For the month, however, volume through Jan. 10 is down 43.5% from $1.15 billion in December. December was the second-best month of last year for sales, after November.

Hard to catch

A strong U.S. stock rally kicked off in early October. The S&P 500 index soared by 12% in the fourth quarter of last year.

This year, in less than two weeks, the benchmark is already up nearly 2%.

This environment helps explain the weaker flow of leveraged notes.

“It’s hard to put new money to work or to know when you’ll be able to. We’re waiting for a pullback but so far it hasn’t happened. I have cash on the sidelines,” said Andrew Valentine Pool, main trader at Regatta Research & Money Management.

“There’s been a lot of autocallables in the last few months. I don’t really know why the market keeps climbing like this. P/Es are getting higher and higher. It seems like many are OK with it. People with their 401Ks are following the noise, apparently ignoring what could happen when we do have a pullback.”

Pool said he has limited use for autocallables, which represent only 10% of his portfolio.

“We prefer leverage but we’ve seen far less leverage in the last couple of months,” he said.

One of his recent picks is JPMorgan Chase Financial Co. LLC’s five-year issue on the MSCI EAFE exchange-traded fund with 2.75 times upside leverage, no cap and a 50% barrier.

“We don’t buy anything domestic right now. The pricing isn’t there. You can’t get terms like this on the S&P 500. It’s too expensive. This market is too rich,” Pool said.

Top deal

What helped last week’s issuance volume was the existence of a few deals in excess of $30 million.

Morgan Stanley Finance LLC priced the top one in $35.73 million of three-year autocallables linked to the S&P 500 index.

The notes will be redeemed at par plus an annual call premium of 7.65% if the index closes at or above the initial index level on any of the annual determination dates.

If the index finishes at or above its initial level, the payout at maturity will be par plus 22.95%.

Investors will be fully exposed to losses if the index declines.

For a change, the top deal was not a worst-of, the sellsider noted.

“Here the trade-off is a reduced coupon versus having a single asset. Since it’s on a single underlying, the issuer has less to work with. But for people who don’t want exposure to a worst-of, getting a lower coupon makes sense,” he said.

The snowball structure helps increase the coupon a little bit, he added.

“There’s a bit of room with the coupon because the moment you get paid is when you stop. It’s not income. However, you do catch up with previous calls. It’s a necessity of the product to have that memory feature. Otherwise, it doesn’t make sense,” he added.

Barclays’ twins

Barclays Bank plc priced $34.79 million of trigger callable contingent yield notes with daily coupon observation due Oct. 13, 2023 linked to the worst performing of the Nasdaq-100 index, the Russell 2000 index and the S&P 500 index.

It was the second largest offering of the week.

This note presented two singularities: an issuer call and an American barrier for the coupon payment.

Each quarter, the notes will pay a contingent coupon at an annual rate of 9.16% if each index closes at or above its coupon barrier level, 70% of its initial level, on each day during that quarter.

The notes will be callable at par of $10 plus any coupon on any quarterly observation date other than the final one.

At maturity, the principal repayment barrier observed point-to-point is at 60%.

UBS Financial Services Inc. and Barclays are the agents.

“Someone wants a 9% coupon for that short tenor. The only way they could do that is by making the barrier American and replacing the autocall by an issuer call,” said the sellsider.

“After all, you see worst-of with three stocks. Having three indices is not egregious. I’m sure the pricing is right.”

Barclays Bank priced $30 million of the same deal under a different Cusip. The terms as well as the 1% underwriting fee were identical to the previous one. Only the annual coupon rate was different at 9.55%.

“It’s strange that they would show a different coupon if all the terms are the same,” said the sellsider.

“It seems like it’s perhaps because UBS priced it on different days.”

The $34.79 million deal priced on Jan. 9 and the other one the day before.

Tactical play on oil

Finally, the fourth deal was a commodities-linked note, a rarefied asset class. Last year’s volume of commodities deals was less than 1% of total sales.

JPMorgan Chase Financial priced $18.16 million of one-year review notes linked to a futures contract for Brent crude oil.

The notes will be automatically called at par plus a call premium of 13.3% per year if the contract price is greater than or equal to the call threshold level, which will be 100% of the initial contract price on the first three quarterly review dates and 70% of the initial contract price on the fourth review date.

If the notes are not called, the payout will be par plus the contract return with full exposure to the decline.

“It’s not so much the structure that’s surprising here. It’s the underlying,” the sellsider said.

“Most Americans don’t look at Brent. They look at WTI. It’s strange to see retail investors betting on Middle-Eastern oil. I can see this as a speculative bet in light of the tensions with Iran.

“Whatever the reason, it’s encouraging. You want investors to look at other asset classes, not just equities.”

The top agent last week was UBS with 71 deals totaling $226 million, or 44.14% of the total. It was followed by Morgan Stanley and JPMorgan.

The No. 1 issuer was Barclays Bank with $143 million in 12 deals, a 28% share.

© 2015 Prospect News.
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