Structured notes issuance volume strengthens; last week’s sell-off boosts yield-oriented bets

By Emma Trincal

New York, May 24 – Structured products issuance remained robust last week despite a sharp equity market sell-off on Wednesday, which saw the S&P 500 index drop 1.8% on political turmoil in Washington around president Donald Trump and the FBI.

Autocallable coupon notes were in favor and may have benefited from the volatility boost, sources said.

Agents priced $400 million in 128 deals, according to preliminary data compiled by Prospect News, which will be revised upward once all priced deals are filed with the Securities and Exchange Commission.

Volume for the year has been exceptionally strong and is up nearly 41% to $19.25 billion from $13.68 billion through May 19. If modified, this year’s notional will only be greater.

“It’s huge,” a sellsider said.

“We’ve had this equity momentum since the elections, something we didn’t have last year and since most structured products are linked to equity, of course it’s a much better environment for offerings.”

Multiplication of deals

The number of deals has also exploded from last year, up more than 75% to 4,948 from 2,808.

This new element is in part the result of last year’s depressed business, this sellsider explained, with firms trying to improve their bottom line as a response to slower sales.

“Last year was very difficult for structured products especially in the first quarter,” he said.

“Volume was down because of the stock market performance. Banks started to become less profitable, they fired people and looked for cash. That’s when many of them moved to automation...automation from pricing to document generation and prospectus delivery. With that you could print $500,000 deals as opposed to a $5 million minimum. “We got smaller deals and a significant increase in the number of deals. Overall, it translated into more volume.

“But it’s still the market that’s behind the surge in volume this year,” he said.

Dispersion

Another market factor that helped volume growth is the decreasing correlation between assets, he noted.

This phenomenon in part explains the success of worst-of deals, which have become one of the most popular structures in today’s market.

“We see more dispersion. Correlations between sectors and markets have started to come down since the elections,” he said.

“Less correlation plays in favor of certain products like worst-of. The economics are better. The coupon a higher,” he said.

A worst-of option will offer more premium (hence a higher coupon) when the underlying assets are not correlated. That’s because investors are taking on more risk, which consists of one of the underliers moving in the opposite direction to the other(s).

Yield reigns

The hunt for yield indeed remained the prevailing theme last week based on what sold most. Fifty five percent of the volume originated from autocallable contingent coupon deals, which represented $222 million in 86 offerings, according to the data.

“Rates are still low. People are still looking for yield,” he said.

“With the volatility spike we had last week, it’s not surprising that we’re seeing a high volume of those deals,” he said.

The autocallable contingent coupon notes, which priced last week, were two-fold.

On top of the list were the larger, multi-asset deals linked to the worst of equity indexes or equity exchange-traded funds.

On a smaller scale, agents priced similar deals but tied to a single stock.

Wednesday plunge

The U.S. markets fell on Wednesday on Washington turmoil with the market fearing that an investigation on president Donald Trump would derail the proposed tax cuts and deregulation reforms, which have fueled the Trump rally since the elections.

The CBOE Volatility index or VIX surged over 15 on that day but finished the week at around 12 as the market recouped on Thursday and Friday. On Wednesday, it was back down again at 10.45.

For this sellsider, sudden volatility spikes, as seen on Wednesday, are an engine of growth for a market, in which yield enhancement remains one of the prevailing themes. To structure those coupons, issuers sell volatility premium and a quick pick up provides better economics to boost the coupon.

Positive volatility skew

This sellsider was not concerned about the market’s low levels of volatility, which many have said is detrimental to good pricing. To him, this usual complaint is overdone.

“As long as the spread between the implied and the realized volatility is positive you can sustain a low volatility environment,” he said.

The VIX is a calculation of the implied volatility, reflecting the market’s expectations in the near-term.

Realized volatility is also referred to as historical volatility.

“The VIX so far has always remained higher than the realized volatility and it can stay like that for years. It’s the reverse that’s abnormal and would constitute an anomaly,” he said.

A market participant agreed.

“You sell the expectation so if the realized is higher, you lose. The good thing is that the realized is almost always lower,” he said.

“That spread is part of the juice you get when you short vol. The higher the implied – the VIX if you will – the wider the margin so it’s easier.

“The problem is timing though. If you sell during these periods when the VIX is below 15, you’re not really helping yourself.”

As a result, days when volatility spikes such as Wednesday last week offer great pricing opportunities for issuers. But the window is short-lived.

Quick sell-offs

Another pattern seen in the market is how quickly the market will recover after a quick bump up in the volatility index, he noted.

Looking at a chart of the S&P 500 index, the market participant pointed to several days in the last couple of years in which a spike in the VIX induced by a sell-off was rapidly followed by the market making new highs.

Some of those sell-offs occurred in August 2015, as well as the early part of last year, last June and November as well as April this year and last week.

“What happens in this market is that until something fundamental happens people will continue to buy the dips and sell the vol.,” he said.

“This is a very positive environment for structured products.”

Shor-term, 3x

The top deal last week was Canadian Imperial Bank of Commerce’s $34.09 million of 15-month capped leveraged notes linked to the S&P 500 index. The upside was par plus 3 times the index return, subject to a cap of 14.88%.

Investors were fully exposed to any index decline.

CIBC World Markets Corp. was the agent.

“This is pretty straightforward...short, simple,” the sellsider said.

“Again this is a typical example of issuers taking advantage of last week’s volatility spike. Volatility is up. You sell it. Your put increases in value. On the upside you get a pretty good cap. That call spread is more of a function of the volatility skew,” he said, referring to the two strikes, one at par and the other at the strike level of the short call option, which is the cap.

Deutsche, Wells Fargo

Deutsche Bank AG, London Branch priced the No. 2 offering with $33.16 million of three-year trigger callable contingent yield notes linked to the least performing of the Euro Stoxx 50 index, the Russell 2000 index and the S&P 500 index.

The contingent coupon was 9.5% per year if the worst-performing index was above a 65% coupon barrier on a quarterly observation date. The notes were redeemable quarterly.

The barrier at maturity was 60% of the initial price for the worst index.

The notes were redeemable at par of $10 on quarterly observation date.

The notes were distributed by UBS Financial Services Inc.

Finally Wells Fargo & Co. priced $20.75 million of two-and-a-half year leveraged buffered notes linked to the SPDR S&P 500 ETF Trust. The payout at maturity was par plus 150% of any fund gain, subject to a 24% cap. There was a 10% downside buffer.

The top agent last week was UBS, which priced 72 deals totaling $76 million, or 19% of the total. It was followed by Barclays and JPMorgan.

Barclays Bank plc remained the top issuer with $80 million in 14 deals, or 20% of the total for the week.

The bank is also the top issuer for the year.

“We’ve had this equity momentum since the elections, something we didn’t have last year, and since most structured products are linked to equity, of course it’s a much better environment for offerings.” – A sellsider

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