Structured products issuance volume tepid in second week of year; agents price $324 million

By Emma Trincal

New York, Jan. 17 – Structured products issuance in the second week of January was not impressive volume wise, according preliminary data compiled by Prospect News. Agents sold $324 million, the same as the revised figures for the previous week at $324 million, the data showed.

Numbers are subject to upward revision on a week-to-week basis based on filing dates and it is still early in the month. But action appears to pick up slowly, sources said, amid a buoyant stock market rally which last week saw the Dow Jones industrial average hitting the 26,000 milestone for the first time.

Smaller trades

As a comparison, last year’s smallest week in notional issuance was just after Labor Day with $230 million. The top one was at $790 million.

“We’re not seeing much excitement in the structured notes market right now,” a market participant said.

“The rally has pushed volatility down even more, and pricing conditions are negative, or perhaps not as favorable as they used to be.”

In all, 127 deals were brought to market last week versus 95 the week before. No large trades have been seen so far this year, not even any deal in excess of $50 million. But the same applied to the first two weeks of last year.

“It doesn’t surprise me that you don’t see deals over $50 million right now. These chunky trades rarely come out early in the month. You’ll see these when the calendar closes on the 26th,” said Jason Barsema, co-founder of Halo Investing.

Indexes and autocallables

Two trends coincided last week, which are established trends by now. First, equity indexes dominated the flow with 57% of the volume versus less than 20% for single-stocks. Second, autocallables, whether structured as pure autocalls paying a premium upon call or contingent coupon autocalls (Phoenix type), combined for 55% of the issuance volume.

“These deals are bought by people already familiar with structured notes. It’s part of someone’s asset allocation,” said Barsema.

“It makes sense at this point given where equity valuations are. People don’t expect the market to go up more than 5% to 7% this year.

“If the market trades sideways you still get a decent return with some protection.

“As the population gets older, more people need income in their portfolio. These are income allocations.”

Diversification

The larger use of equity indexes is a trend overlapping the income trend as many of the contingent coupon deals were structured as worst-of deals based on two or three indexes, the data showed.

“People have to do worst-of to get decent coupons. But they’re not necessarily crazy about the risk. People feel more comfortable doing worst-of with indices because the diversification of the index reduces some of the market risk you’re taking,” the market participant said.

Top deal

An example was last week’s top deal.

Deutsche Bank AG, London Branch priced $26.6 million of four-year trigger callable contingent yield notes with daily coupon observation linked to the least performing of the Euro Stoxx 50 index, the Russell 2000 index and the S&P 500 index.

Each quarter, the notes pay a contingent coupon if each index’s closing level remains at or above its coupon barrier, 65% of its initial level, on each day during that quarter. The contingent coupon rate is 9.2% per year.

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

If the notes are not called, the barrier at maturity observed on a point to point basis for the worst-performing asset is 60%.

UBS Financial Services Inc. distributed the notes.

“This gives you a pretty good yield but you get it from the daily observation. A daily-observed structure can make you gain an additional 200 basis points. But there is a greater risk of breaching the barrier and you have to be comfortable with it. I know that I’m not,” Barsema said.

UBS was the top agent last week with $135 million in 78 deals, or 41.8% of the total.

“They’ve grown a ton. That’s because of their willingness to drop their minimum notional size,” he said.

Digital for hedging

The second largest deal was a digital note, which delivers the fixed return if the index is up or even negative by less than 15%.

Canadian Imperial Bank of Commerce priced $23.63 million of 0% digital notes due March 16, 2020 linked to the S&P 500 index.

The digital return of 12.8% is paid at or above the negative threshold. When the index drops more than 15% investors will lose 1.1765% for every 1% that the index declines beyond the buffer.

CIBC World Markets Corp. is the agent.

“This is a hedge. It can give you a good conversation with a client. If the index is down 10% you’re up 12.8%,” said Barsema.

The tradeoff however is the geared buffer. In case of a deep market decline, investors do not benefit from the same protection as a straight buffer, he noted.

Leverage

Appetite for leverage was still there. Those products made for 26% of total volume in 26 deals totaling $85 million. About 70% of this volume was built around defensive structures, which include a buffer or a barrier.

“We’ve seen a number of those deals. There is always demand for those products. First-time buyers of structured notes are not going for the autocallable contingent coupon notes,” said Barsema.

“They buy leveraged notes with buffers.”

Tax harvesting

In addition, a seasonal factor may have helped issuance of those plain-vanilla leveraged products tied to an equity benchmark, he noted.

“At the end of the year, people sell some of their positions. They harvest on unrealized losses for tax purposes. They can’t buy the same assets due to the wash sale. But they have proceeds to invest. That’s when you buy a leveraged note to an index. It gives you the exposure to the market without triggering a wash sale. We’ve seen that a lot especially when the stocks that have been sold are big constituents of an index.”

A wash sale as defined by the Internal Revenue Service is a trade that occurs 30 days after the sale at a loss of an identical security. The IRS rule prohibits investors from claiming a tax deduction the second time when the two sales occur within that short period of time.

How much higher

UBS AG, London Branch issued the third deal last week in $17.22 million of 2¼-year notes linked to the S&P 500 index. The leverage is 1.5 times and the cap, 23.10%. The 15% buffer is geared at a rate of 1.1765.

The use of buffers and barriers was justified by the mixed reactions in the face of last week’s full-blown rally.

“There is some nervousness about the pace of this rally. We have clients who haven’t done a structured note for 12 months and they are now loading up.

“It’s not that they’re seeing the bull market coming to an end necessarily.

“But they expect lower returns and they think it’s time to get some protection on the downside,” he said.

Barsema said he expects a 10% to 30% pullback within the next two years.

“Look at employment. Look at wages. If inflation is creeping up we’ll see a pullback, and it would be healthy. We need one,” he said.

“As long as we don’t have another Lehman Brothers moment – and I don’t think we will...this was a once-in-a-lifetime event – it would actually be good for our industry.

“Volatility would pick up. People would buy.

“In that regard, I think 2018 is going to be a great year for structured notes,” he said.

UBS AG, London Branch was the No. 1 issuer with $60 million in seven deals.

“We’re not seeing much excitement in the structured notes market right now. The rally has pushed volatility down even more, and pricing conditions are negative, or perhaps not as favorable as they used to be.” – A market participant

“It doesn’t surprise me that you don’t see deals over $50 million right now. These chunky trades rarely come out early in the month.” – Jason Barsema, co-founder of Halo Investing

© 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.