Agents sell $237 million to start Q3; single-index pricing improving; leverage still declining

By Emma Trincal

New York, Oct. 14 – The first week of October kicked of with $237 million in sales of structured notes in 122 offerings, according to data compiled by Prospect News.

Top deals were modest in size but showed the particularity of not being structured as “worst of,” a sign that pricing conditions may be changing.

On a year-to-date basis, volume is up 38.6% to $52.56 billion from $37.91 billion. This increase shows a deceleration compared to the advance recorded earlier in the year. It may be because last year’s sales built up in momentum toward the end of the year with May, August, October, and September being the best months after November. In contrast, the top months this year were March followed by February and January.

Ultra-high net worth

“My experience with the February and March sell-off is that terms were fantastic. Ultra-high net worth could buy one or $2 million tickets and so they were able to take advantage of the market in one day. They could go in very quickly,” a sellsider said.

The number of deals this year reached 16,292, a 31% increase from last year’s 12,409 through Oct. 9.

Just about as many deals have printed so far this year as through the full year of 2019, which showed 16,293 offerings.

Last week’s volume was typical for the early part of a month. It is possible that activity may have somewhat slowed down ahead of banks’ earnings announcement this week. JPMorgan and Citigroup reported their results on Tuesday, Goldman Sachs and Bank of America on Wednesday, and Morgan Stanley, Thursday.

Almost no leverage

As observed above, the proportion of leveraged notes continued to decline last week, but at a steeper pace than usual.

Autocallable structures made for $137 million in 104 deals, or 58% of the total. Meanwhile, only five leveraged return deals totaling $21 million were issued. These figures, as well as the week’s volume, are subject to change after firms file all their offerings with the Securities and Exchange Commission.

But the decline in leveraged notes has been a trend for some time.

For the year to date, the decline in market share for growth is more noticeable with buffered or barrier leveraged products (17% of the total from 24% the year previous) than with full-downside-exposure leveraged notes (9.5% this year from 11% in 2019), according to the data.

“Bullet pricing has never been so tough,” the sellsider said.

He was referring to plain-vanilla leveraged return notes, also known as growth notes, which tend to have no call feature.

He gave an example of a deal, which priced on March 23, the day when the market bottomed. The principal behind the trade was Raymond James, he said. Morgan Stanley Finance LLC then sold $13.56 million of six-year leveraged notes linked to the Dow Jones industrial average and the S&P 500 index. Investors will get 2.7 times any gain in the lesser-performing index.

At maturity, the trigger level for each index is 50%.

“This is a feel-good story,” he said.

“Today if I used the same terms, I don’t even know if I could do it one-to-one,” he added, referring to the upside.

Low rates

The supremacy of autocalls at the expense of leverage has more to do with funding rates than with volatility, he argued.

“Volatility is a lot lower than it was in March and April. But it doesn’t explain the difference in pricing for bullet notes,” he said.

“Funding spreads have tightened significantly and that gives you less to buy for the upside. That’s the problem. Growth deals don’t really work.”

“I’m not even talking about CDs. Those just don’t happen anymore. We’re not even getting them out right now.”

Principal-protection products such as market-linked CDs are based on zero-coupon bonds which price at a discount to par. Issuers use the discount to purchase the call options. When rates are lower, the amount of capital the issuer has available to put together the structure decreases.

For the sellsider, the current prevalence of autocalls is in large part the result of low rates not just from a pricing standpoint but also because investors are anxious to get income.

“Callable or autocallables with contingent coupon are now 100% of our business,” he said.

“There is not much plain-vanilla leveraged notes issuance right now. That’s what’s missing in our business.”

This does not necessarily mean volume won’t rise overall. But the growth of autocall issuance is somewhat tied to that of the overall market, he said.

“Most autocalls have been called. There’s a lot of money to put back to work,” he said.

It is not clear however how much gets reinvested.

“It’s hard to quantify. Generally, if the notes are called after six months, that means it worked pretty nicely for the client and they’re probably going to reinvest.”

Stocks and volatility

Equity index underliers took center stage last week with 70% of total issuance while single stocks accounted for only 16%. These market shares are in line with the yearly average.

However, single stocks tend to be used more when volatility is low than when it’s high, perhaps to extract a premium not easily found on the broader market. For instance, during the bear market of mid-February to the end of March, the share of single stocks in the total notional issued was only 6.7%, according to Prospect News data. It rose to 19% during the recovery rally from April to August. There are no set rules, however. September was a volatile month and single stocks captured more than 20% of the total.

Duration

“Pricing conditions can’t be boiled down to one factor only,” the sellsider said.

Volatility, rates and dividends paid by the underlying are the main component of options pricing. But some other factors are important as well, he added, pointing to duration.

“There’s a huge pricing difference between a three-month no-call and a one-year no-call,” he said.

“The shorter your call period, the higher your yield.

“Sometimes you can see a difference of up to 1% or 2%.

“It has to do with your expected life. The shorter your expected life, the better your yield.”

Dispersion premium

The sellsider noticed that for some maturities, single-underlying deals may price almost as well as worst-of deals.

It was visible last week with the top three deals based on a single index.

“It’s kind of interesting. Take a one- or two-year contingent coupon autocall. If you compare one tied to the worst of the S&P and the Dow and the other to the S&P only, the coupon on the worst-of will be lower, which makes no sense, at least at first glance,” he said.

He cited a few possible explanations.

“The correlation is not at a significant premium right now. You’re paid a little bit but not as much as before,” he said. He was referring to the extra premium investors may get from a worst-of when the underliers show low correlations with one another.

“Also, there’s a cost of hedging a worst-of. They’re more complex, they’re done on the exotic desk. It’s more expensive to hedge, making the pricing worse.”

This sellsider said he has noticed this anomaly mostly on 12-month paper.

“The difference between the S&P versus the S&P and Dow has really squeezed.”

“I couldn’t tell you if this a sign that worst-ofs are getting less attractive. Whenever the economics of something work, that’s what people are going to do.”

Two Scotia

Bank of Nova Scotia priced last week’s top deal in $22 million of six-year autocallable market-linked step-up notes on the S&P 500 index with BofA Securities, Inc. acting as an agent.

The notes are automatically called if the index closes at or above its initial level on an annual basis.

If the index finishes positive but below the step-up value, 135% of the initial price, investors receive par plus 35%. Above the step-up level, the participation is one-to-one. There is a 15% buffer on the downside.

The same issuer priced the second deal for $20.98 million, distributed by UBS. It was a three-year autocallable contingent coupon issue on the Nasdaq-100 index paying an 8% coupon based on a 70% coupon barrier. The notes are automatically called quarterly if the underlying is above its initial price. The barrier at maturity is 70%.

“In this case, obviously, volatility is there with Nasdaq. So that helps,” the sellsider said.

Fixed rate

Next, Barclays Bank plc priced $17.62 million of one-year 4.75% callable yield notes linked to the S&P 500 index with monthly interest payments. The notes are callable after three months. The principal repayment barrier at maturity is 60%.

The small coupon rate along with the issuer call facilitated pricing, the sellsider said.

“My bet is that we’ll see more of guaranteed coupons,” a market participant said.

“If your biggest concern is the downside protection and getting a fixed return, you can accomplish that with a structured note.

“I can buy a mix of indexes with a guaranteed coupon over three-year and a 25% barrier at maturity. I can earn 6.5% per year. It’s not bad and I can use it to protect myself at maturity.”

Better days ahead

Of interest among the few single-stock deals, UBS AG, London Branch priced $10 million of 15.6% airbag autocallable yield notes due Oct. 13, 2021 linked to Delta Air Lines, Inc. Typical of what has been called the “recovery trade” –bullish bets on the economy – UBS priced other deals on stocks, which are expected to do well once the Covid-19 crisis is over. An example was four issues of phoenix autocallables linked to Wynn Resorts, Ltd. totaling $1.4 million.

Other examples of the economic-recovery trade included deals tied to biotech or pharmaceutical stocks such as UnitedHealth Group Inc., SPDR S&P Biotech ETF, Gilead Sciences, Inc. and Pfizer Inc.

UBS was the top agent last week with $106 million in 102 deals, or 44.7% of the total. It was followed by Goldman Sachs.

Bank of Nova Scotia was the No. 1 issuer with $43 million in two deals.

For the year, Barclays remained the top issuer with $7.7 billion in 1,583 offerings, a 14.6% share.

© 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.