Despite selloff, volatility is still too low to boost coupons, raise caps, sellsiders say

By Emma Trincal

New York, Aug. 23 – Notional volume has jumped this year with exceptional strength. But some sellsiders are cautious about how to interpret the data, stressing that sales rely mostly on sentiment at this time as the pricing environment has yet to improve.

Volume rose to $31.73 billion for the year through Aug. 18 from $22.15 billion during the same time last year, a more than 43% increase, according to data compiled by Prospect News.

Volume in the 12 months to Aug. 18 is up 30% to $48.31 billion from $37.15 billion in the same period a year earlier.

“That’s interesting. We’re not feeling it,” a sellsider said.

“Any higher rates, higher volatility would be so helpful for our business.”

High entries

A distributor catering to registered investment advisers agreed.

“The summer is slow. You may see a 30% pick up, but much of the volume as of late has been wirehouse volume, not third-party,” he said.

“There is an argument to be made that you want downside protection since the market is so high. But volatility is so low. It doesn’t help especially with traditional leveraged buffered notes.”

Leveraged notes with or without partial protection amount to slightly less than $10 billion this year, just as last year. But these types of products have seen their share diminish this year to 31% of total volume from 44% last year, according to the data.

“I speak to advisers who tell me that they’re no longer doing structured notes because volatility is too low, they can’t get enough upside. ‘If we see the market coming in and volatility spike, I may get back in and get a lower entry.’ I guess that’s what people who used to do plain-vanilla leveraged return notes are telling me,” said the distributor.

Thursday’s selloff

Yet last week offered one of the worst selloff for the year amid controversies surrounding the White House after the protests in Charlottesville, Va. and rumors that one of the president’s key adviser responsible for the implementation of the tax reform was about to resign.

The Dow Jones Industrial average fell 275 points on Thursday or 1.2%, its biggest decline since May. On the same day, volatility as measured by the CBOE Volatility index surged by a third to 15.50.

On Wednesday this week, the “fear gauge” had returned to a lower level below 12. The long-term average for the VIX is above 20.

“The VIX is still in the low double digits. We’re seeing some volatility in the vol index but within a narrow range,” a market participant said.

“You’d have to see a lot more sustained volatility to significantly affect pricing.”

Interest rates, against all expectations earlier this year, have decreased, not risen.

The 10-year Treasury yield was 2.45% in the beginning of the year. It is 2.18% today.

“This year shows more volume than last year. But you have to think of what you’re comparing it to. Last year was not a particularly good year,” he said.

Popular structure

To compensate for the lack of volatility-induced premium, issuers have introduced correlation risk, which is another way to generate yield, sources said.

This explains one of the key tools supporting pricing this year: an explosion of worst of structures.

To get a sense of the widespread use of those products, last week recorded $113 million of worst of in 34 deals. This represented no less than 45% of the $252 million of notional sold and nearly 30% of the 118 deals that priced, according to the data.

“It’s still a popular structure,” the sellsider said about worst of deals.

“Everybody’s dealing with the same problem: you can’t find yield. Volatility picked up last week. But we’re still off all-time highs. It’s still a product that’s working.”

Top yet small deals

Last week’s top deals were modest in size, according to data available at press time.

Apparently the selloff did not impact volume in a positive way, the distributor said.

“It’s too early to see. Most deals are already out for this month,” he said.

“A lot of the volume is calendar deals. It’s going to take a few months of selloff to see a difference.”

The largest deal to price last week was Canadian Imperial Bank of Commerce’s $17.5 million of 3.25-year capped buffered notes linked to the S&P 500 index.

The payout on the upside will be any gain capped at 14.9%.

The notes include a 20% geared buffer on the downside with a 1.25 multiple.

The agent is CIBC World Markets.

Next, GS Finance Corp. priced $15.13 million of 10-year contingent income callable securities linked to the S&P 500 index.

Each quarter, the notes will pay a contingent coupon at an annual rate of 7% if the index closes at or above its coupon threshold level, 75% of its initial level, on the observation date for that quarter.

The notes are callable after one year.

The payout at maturity will be par plus the final coupon, if any, unless the index finishes below the 65% downside threshold level, in which case investors will lose 1% for each 1% decline.

Morgan Stanley Wealth Management is acting as dealer.

Deutsche Bank AG, London Branch priced a three-year worst of for $15 million providing a contingent coupon linked to the Euro Stoxx 50 index, the Russell 2000 index and the S&P 500 index. The coupon paid on a quarterly basis is 9.5% per year based on a 70% coupon barrier. The notes can be called on any quarterly observation date. At maturity, the point-to-point barrier is 60% of the initial price of the worst-performing index.

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

ETF worst of

The significant number of deals based on exchange-traded funds was noticeable last week.

This asset class makes up 6.50% of the year-to-date volume. It jumped to nearly 12% last week, the data showed.

“I can see why this would be a trend,” the distributor said.

“ETFs are easier to manage for the issuer because you can hedge them. If you’re going to trade the ETF to hedge the note, you might as well put it in there.”

Most of those ETF-linked products seen last week used a worst of payout.

The largest in this group was Morgan Stanley Finance LLC’s $9.53 million of two-year callable contingent coupon notes linked to the least performing of the iShares U.S. Real Estate ETF, the VanEck Vectors Semiconductor ETF and the SPDR S&P Bank ETF. The contingent coupon is 11.52% based on a 60% coupon barrier in the same level as the final trigger.

Barclays Bank plc did another one for $9.18 million. A two-year product, it was linked to the least performing of the iShares Nasdaq Biotechnology ETF, the Financial Select Sector SPDR fund and the Technology Select Sector SPDR fund. Its annual contingent coupon was 10.75% with a 75% barrier similar to the final trigger level.

The top agent last week was JPMorgan with 27 deals totaling $72 million or 28.76% of the total. It was followed by Barclays and UBS.

JPMorgan Chase Financial Co. LLC was the top issuer showing the same volume and number of deals as its affiliate.

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