Low yields, toppish bull push structured products investors to bid on autocalls; volume up 41%

By Emma Trincal

New York, July 19 – As last week’s stock market hit new highs, structured products investors continued to crowd income and yield-generating trades as if the perception was clear that the market has not much more room to grow, sellsiders said.

Expectations of reflation and higher interest rates, which prevailed after the November elections through the earlier months of the year, have all but vanished, causing investors to seek yield as a safer alternative to mere bull plays.

Such a trend has been seen through the entire year. For sources, it is partly what fueled the strong increase in issuance volume in 2017.

Year is up

Sales in structured notes this year through July 14 are up 41% to $27 billion from $19.15 billion last year, according to data compiled by Prospect News.

“That’s a huge increase,” a sellsider said.

As the market has begun to enter a seasonally weaker period, a look at growth from a rolling period may be more telling.

Volume between July 1, 2016 and June 30, 2017 is up 26% compared to the same period in 2015-2016, the data showed.

“This eliminates some of the noise and shows what the industry is doing overall. If we’re up 26% on a 12-month rolling period, we’re doing really good,” he said.

Structured notes advantage

The main factor for growth was the bull market but also the uncertainty around the timing for its inevitable ending, he said.

The S&P 500 index is up more than 10% for the year. Since the beginning of the bull market in March 2009, the benchmark has gained 262%.

“The stock market has been doing really well. Again, we just broke new records. People are saying: now what? Investors know that it’s getting pricey,” he said.

“Why buying stocks at these levels? Structured products with either leverage or buffers or income features let you get in on your own terms. It’s a safer way to get exposure.”

As a result, income or yield generating structures were the star products last week.

Plenty of autocallables

Autocallable contingent coupon notes made for 56% of total volume, according to the data.

Pure autocalls, which pay a call premium instead of a coupon, represented more than 11% of the market.

Adding both categories, two-thirds of last week’s notional went into notes designed for yield, rather than participation.

Leverage as expected was not much in favor: it represented less than 20% of the volume.

“Leverage is expensive. You have to buy these options. It’s easier now to offer protection on an autocall than on a leverage note. Participation doesn’t sell well,” a structurer said.

Bad news is good news

Investors also seem to realize that interest rates are likely to stay low for a while given the low inflation and disappointing economic results. This is the main cause for the bid on yield-based products, the sellsider said.

The market rallied last week on bad news anticipating that the Federal Reserve will be more dovish than expected before, a trader said. This view was reinforced by Fed chairman Janet Yellen’s remarks before Congress hinting that the Fed may hold off a rate hike due to a relatively weak economy.

Two disappointing economic indicators released Friday sparked a late-week rally as they showed a flat CPI and a slight decline in retail sales for June.

It was good news for the stock market. The S&P 500 index jumped up 1.4% finishing the week on a new record high.

But for many investors depending on income, the need to find solutions is ever more pressing, the sellsider said.

“The yields are still stubbornly low. Where are you going to put your money for income? People are buying these autocalls because those products solve a problem. They’re designed to give you a higher yield. For a lot of savers or retirees, the priority is not participating in the market. It’s income,” he said.

The two top deals were callable structures, one with a discretionary call, the second with an automatic call.

Discretionary call

Deutsche Bank AG, London Branch’s $39.5 million of three-year callable contingent coupon notes linked to the least performing of the Euro Stoxx 50 index, the Russell 2000 index and the S&P 500 index accounted for the largest offering.

Each quarter, the notes pay a contingent coupon if each index’s closing level remains at or above its coupon barrier, 70% of its initial level, on each day during that quarter. The contingent coupon rate is 10% per year.

The notes are redeemable at par of $10 on any quarterly observation date other than the final one.

“The barrier observed any day plus the discretionary call add risk therefore they can boost the coupon, which is why you’re getting a 10%. Also it’s a worst-of on three indices,” a source said.

There is a 60% barrier at maturity in the event that the notes are not called.

UBS Financial Services Inc. and Deutsche Bank Securities Inc. are the agents.

“There is no call protection. On a three-year you can usually put a no-call. Not so great for the investor if you get called after three months with only 2.5%. But it definitely allows the issuer to give you a higher coupon, so I’m sure it was structured that way for a reason,” said the sellsider.

Earnings play

Next was Barclays Bank plc’s $20.87 million of three-year autocallable income securities linked to Bank of America Corp.

The notes will pay a contingent quarterly coupon at an annualized rate of 9.2% if the stock closes at or above the downside threshold level, 80% of the initial share price, on a determination date for that quarter.

The notes will be called at par of $10 plus the contingent coupon if the shares close at or above the initial level on any determination date other than the final date.

The payout at maturity will be par unless the stock finishes below its downside threshold, in which case investors will be fully exposed to any losses.

Morgan Stanley Smith Barney LLC will be handling distribution.

“I can see that they may have done that just before the earnings when they can capture more premium,” the sellsider said.

The deal priced on Friday, ahead of Bank of America’s second-quarter earnings announcement.

Volatility tends to spike just before earnings as options traders make more bullish or bearish bets on the stock than usual.

Barclays was the No. 1 agent last week with $81 million in 15 deals, or 23% of the total volume. It was followed by Deutsche Bank and JPMorgan.

Barclays Bank plc was also the top issuer last week and remains on top for the year.

“The stock market has been doing really well. Again, we just broke new records. People are saying: now what? Investors know that it’s getting pricey.” – A sellsider

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