Structured products issuance $571 million for week in mixed market; absolute returns gain appeal

By Emma Trincal

New York, May 23 – Agents priced $571 million in 166 structured products deals in the week ended Friday versus $609 million in 169 deals in the prior week, according to data compiled by Prospect News. As the market remains uncertain and choppy, more investors are contemplating absolute returns as a way to prepare for a potential sell-off.

Speed bumps

The U.S. equity market ended flat last week after several speed bumps with investors preoccupied by rising interest rates. Geopolitical concerns, trade talks and higher oil prices were also at the forefront of the news. But while the markets can show wild swings almost daily, the overall performance of the market remains range bound. This year, the S&P 500 index is up only 1.6%.

“The markets go up and down in a few days and often within one day. But it’s a sideways market. Is this a good thing for structured notes? It depends on what you own. If you own income structures, that’s great. It’s just the right market for those products,” a structurer said.

In fact, after a couple of weeks showing more growth products than usual, last week’s pendulum shifted the other way toward income or fixed return notes. Autocallable contingent coupon notes made for 35.3% of total volume while pure autocall plays paying a one-time call premium represented 13.2%, bringing the total of those structures to nearly half of what priced last week.

Month, year

For the month to date volume has dropped 13.4% to $1.49 billion from $1.72 billion, according to the data. From a year ago however the decline is only 2.6% from $1.53 billion in May 2017 through the 18th.

For the year, issuance volume remains solid, up 21% to $23.11 billion from $19.1 billion last year, according to the data.

More deals came to market this year, rising by nearly 25% to 6,080 from 4,899.

Rates

Rising interest rates have disrupted the bull market this year and introduced more volatility. Last week the 10-year Treasury yield hit 3.11%, its highest level in nearly seven years, which caused some anxiety among investors. But what is not good for stocks can help make products more attractive, a distributor said.

“Interest rates going up are already making the deals more attractive. Principal-protected notes are now possible,” he said. “Contingent coupon deals, capped leveraged buffered notes, all look better. It’s a boost for the industry, not an obstacle.”

A sellsider noted that what he is noticing in the market are products that benefit from higher interest rates.

“The two things we’re seeing more are rate products and principal-protection,” he said.

“Among the rates, we’re seeing steepeners or step-up notes.

“Pricing looks attractive on the steepeners. You get better terms because rates are going up so it works even though the curve is flattening.”

Rate-linked notes remain very small in size. The largest last week was Royal Bank of Canada’s $2.5 million issue of leveraged steepener notes linked to the spread between the 30-year Constant Maturity Swap rate and two-year Constant Maturity Swap rate.

However, volume is exploding in this asset class this year, up more than 200% to $604 million this year from $198 million during the same time in 2017.

Absolute return

In a market moving a lot intraday or within a week and with the perception that the nine-year old bull market will not last forever, investors have been seeking protection in leveraged notes. Another risk-off bid has been seen on absolute return trades. While recent, the reemergence of those structures is something to keep one’s eyes on.

Absolute return notes, also called dual directional notes, amounted to $41 million last week in five offerings.

It turns out that the largest deals in the absolute return structure group were also defensive notes thanks to an innovative structure, which UBS introduced last week.

Innovative structure

One of those and the top deal of the week was an absolute return note with protection. Several sellsider sources said they had not seen such a product before. The notes bring absolute return while guaranteeing 102% at maturity, making the structure more than just protective.

Credit Suisse AG, Nassau Branch priced $33.48 million of two-year barrier absolute return notes linked to the S&P 500 index featuring an upper barrier and a lower barrier. Both barriers are American barriers: the barrier can be breached any day during the life of the notes.

The barrier will be breached if the index any time closes above the upper barrier, 120% of the initial level, or below the lower barrier, 80% of the initial level. In such case, investors receive a fixed return of 2% at maturity.

If the price is contained within the 80% to 120% range at all time during the life, the payout is one-to-one the index return with absolute return on the downside. UBS Financial Services Inc. is the agent.

Not replicable

“I haven’t seen something like that before. I don’t not like it,” the structurer said.

“You’re long a knock-out call and long a knock-out put, which are relatively inexpensive. That allows you to still be able to pay investors 2% or 1% per annum.”

He explained the pricing further.

“You’re long an at-the-money knock-out call. Before +20%, the calls pays out from initial price. If you’re above 20%, the call gets knocked out.

There would not be any listed options for this type of payout, he noted.

“You wouldn’t be able to recreate that on your own,” he said.

Managing expectations

The product is so different from the traditional absolute return structure that it is difficult to compare both – the common one and this version, he noted.

With the traditional at-risk version, this structurer says he may worry about how clients may have “the wrong expectations.”

“You really have to explain it well. People can be confused. Clients will look at their position after one month, they see the index down 10% and they may easily reach the wrong conclusion: ‘great as long as I don’t breach the barrier, it’s an absolute return...I get +10%.’ They don’t get it that it’s only the price at maturity that matters sometimes.”

These concerns related to how clients read their statements or positions online may not apply so much to a note structured on an American barrier, he said.

One redeeming factor is the 102% guaranteed return, he said, making the structure fall into the category of principal-protected notes.

“It’s interesting. It has features that we’ve seen here and there, but not combined,” he said.

The notes priced on Wednesday.

Credit Suisse priced another similar deal tied to the same index on the same day for $2.53 million. The tenor was 18 months instead of two years. The upper and lower barrier was set at 117% and 83%, respectively, giving a 17-point range on each side. The fixed return in the event of a barrier breach was 1.5%. UBS was also the agent.

95% protection

As an example of another defensive product, Morgan Stanley priced on the behalf of Barclays Bank plc $24.82 million of two-year partial principal at risk securities tied to the MSCI Europe index. It was the fifth largest deal of the week.

The payout at maturity will be 1.37 times any index gain, capped at 40%.

If the index declines, investors will receive par plus the index return, subject to a minimum payout of 95% of the initial price.

Barclays issued a similar note with the same unusual underlying on April 30 for $23 million.

Six months ago, such principal-protected structures over just two years would have not been possible, sources said, pointing to one of the benefits of higher rates.

Other deals

The No. 2 deal was GS Finance Corp.’s $30.8 million of five-year step worst-of autocallable notes linked to the lesser performing of the S&P 500 index and the Euro Stoxx 50 index. A quarterly autocall will pay 8.35% per year if each index closes at or above its initial level. The principal barrier at maturity is at 60% with a 41.75% premium above initial price.

Royal Bank of Canada priced $30.68 million of 13-month leveraged notes linked to the S&P 500 index.

The payout at maturity will be par plus 3 times any index gain, up to a maximum return of 12.25%.

Investors will be exposed to any losses.

UBS is the agent.

The top agent last week was UBS with 78 deals totaling $200 million, or 35.12% of the total. It was followed by Morgan Stanley and Goldman Sachs.

On the issuers’ front, Barclays Bank plc was No. 1 with seven offerings totaling $89 million. Closely behind was GS Finance Corp. with $88 million in 28 deals.

“The markets go up and down in a few days and often within one day. But it’s a sideways market. ... If you own income structures, that’s great. It’s just the right market for those products.” – A structurer

“The two things we’re seeing more are rate products and principal-protection. Among the rates, we’re seeing steepeners or step-up notes.” – A sellsider

© 2015 Prospect News.
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