Low volatility, rates impact structured products issuance volume; $318 million priced for week

By Emma Trincal

New York, March 27 – Agents sold $318 million of structured products in the week ended Friday, in line with the $327 million priced in the previous week, according to updated figures compiled by Prospect News.

The S&P 500 index lost 0.8% on the week.

In equities, the market rallied on Thursday in reaction to the Federal Reserve’s decision to leave rates unchanged the day before. But bad news came from the yield curve on Friday when the yield curve between the three-month and 10-year Treasuries inverted, pushing recession fears to the forefront and sending stocks down. The CBOE Volatility index jumped on that day but finished at 16.48, which remains below the historical average.

“In February last year, volatility was up to the roof. A great way to play volatility is through structured notes, which translated into a strong volume last year. Now volatility is down again, so it’s a challenge. That said our shop is pricing record volume. But it may also be due to our organic growth,” said Jason Barsema, co-founder and president of Halo Investing, Inc.

Yield shock

The yield inversion scare last week could bring back more volatility into the market. At the same time, rate compression and a more dovish Fed are not conducive to better terms, he said.

“The market is pricing in a rate cut. How things have changed in just a few months. People used to fear that the Fed would hike rates. Now that it’s no longer tightening, the market is worried about a recession. It went from: ‘Oh great! They’re dovish...to the Fed is dovish! That’s horrible! Welcome to the stock market,” he said.

But there is logic behind such fear, he added.

“Rates are going down. The [European Central Bank] has announced they will hold rates. In the U.S., the Fed is keeping the rates low. From an economic perspective, you have to ask: how many bullets do we have left in the chamber? If we’re going into a recession, we don’t have much room to cut. The ECB certainly has no room to cut. Their rates are negative.”

The number of deals was 161 last week versus 159 seen the previous week. The weekly average for the year is 227, but the number is skewed by month-end pricing, which is bulky. Deal sizes were small with only one offering in excess of $20 million.

More stocks

For the underlying asset classes, equity indexes dominated as usual with 69% of the total while single-stocks made for a 20% share. The proportion of stocks, however, was higher than the year-to-date average of 11% just as the indexes were below their 75% average.

Last week did not include any interest-rates-linked notes, according to this publication’s definition.

Prospect News excludes plain-vanilla rates deals, such as step-up notes, fixed-to-floating rate notes and capped floaters as well as products linked to Libor. Overall, rates-based notes that display limited optionality are not included.

Structure-wise, there were no leveraged notes with full downside exposure, which is unusual and suggests renewed concerns about market risk. Leverage with barrier or buffers made for 31.5% of total notional, which was much less than income-oriented notes accounting for 45.5%. On average, leverage tends to prevail over income.

Worst-of momentum

Overall, the amount of worst-of notes was significant: $114 million, or more than a third of total notional.

Almost all such structures were built on equity indexes. Less than $6 million of worst-of deals were based on stocks.

“When you have low interest rates and low volatility, you need to get a little bit more creative to generate the premium. That’s why you see more worst-of,” Barsema said.

Sometimes issuers and distributors change the terms of a generally accepted tradeoff to appeal to the needs of some of their customers.

For instance, some autocallable contingent coupon notes now feature memory coupons. Barsema indicated that his firm has moved in that direction.

“Memory coupons are very typical in Asia or in the Middle-East. From talking to some of our clients, we found that there is a concern about missing some of the payments. They’re willing to sacrifice some of the yield so they can make up for any lost coupon,” he said.

Index underliers

The most commonly used indexes were the Russell 2000 with the S&P 500 indexes to which another benchmark was often added such as the Nasdaq-100 or the Euro Stoxx 50. In some instances, an exchange-traded fund served as a third underlying along with the S&P/Russell pair to enhance the yield, for instance the MSCI Emerging Markets fund or even more pointedly the iShares MSCI Brazil ETF.

Stock ideas

There were no clear patterns on single-stocks except for some aircraft tactical plays driven by the tragic recent Boeing crash. American Airlines Group Inc. and Boeing Co. were used but mostly as stand-alone underliers.

For stock worst-of deals, issuers used baskets such as Kraft Heinz Co., Delta Air Lines, Inc. and Netflix, Inc. Another play was Broadcom Inc., Splunk Inc. and Boeing. Some single-stock deals were seen in finance with Bank of America Corp. and health care with CVS Health Corp. along with the usual tech stocks such as Apple Inc. and Nvidia Corp.

Investors are seeking volatility in some catalysts induced by the headlines. When a macroeconomic event occurs, such as the yield curve inversion, conditions improve for the industry, sources said.

“When you see volatility picking up like Friday, there’s an incentive to get in. People have some dry powder and the rationale is: let’s put some money to work before volatility falls again.

“When you buy a barrier, you’re actually selling volatility. It’s when volatility spikes that you’re going to want to lock that in.”

Euro Stoxx fading

Across all structures, last week showed an anomaly. There was only one deal tied to the Euro Stoxx 50 index as a sole underlier: a Barclays Bank plc $3 million trade.

“People have become more concerned about Europe given the Brexit that has been dragging on for the past two years,” said Barsema.

Other concerns include Germany’s economic slowdown, the Italian budget problem and France’s political crisis with the Yellow Vest protests.

Year-over-year decline

Volume for the year-to-date continued to be alarmingly weak, nearly down by half from last year.

Agents sold $8.15 billion through March 22, a 43.5% drop from last year’s $14.43 billion, according to the data.

The number of deals has dropped as well, down 28% to 2,717 from 3,793.

“A lot of that is because volatility was disturbingly low last month. Everybody is waiting for volatility to go back up,” said Barsema.

Range bound market

David Chojnacki, portfolio manager of Sabretooth Advisors, noted that the S&P 500 index has been trading range bound over the past couple of weeks.

“We seem to have a hard time breaking out of the range. Volatility has been low. It rose a little bit last week, with the yield curve inversion that triggered a sell-off,” he said.

On Monday, the market was up again.

“It’s hard to see whether volatility is going to come back until we get into the earnings season next month.

“Right now, I don’t see the market moving out of its narrow range.”

For the general market, the impact of low interest rates is two-fold.

“Equities always love lower rates,” he said.

“But it’s killing the bond market in the sense that it hurts the long-end. The inversion suppresses the incentive to go long on the curve.”

Top deals

The top deal last week came from Wells Fargo & Co., which priced $32.64 million of two-year leveraged buffered notes linked to the S&P 500 index. The payout at maturity is par plus 150% of the index gain, subject to a 20.475% cap. Investors will receive par if the index falls by up to 10% and lose 1.1111% for every 1% decline in the index beyond 10%. Wells Fargo Securities, LLC is the agent.

Deal size dropped with the second offering: Morgan Stanley Finance LLC’s $19.96 million of five-year leveraged notes tied to an equally weighted basket of the Russell 2000 index and the S&P 500 index. The uncapped upside is levered at a rate of 1.5. The downside offers a 60% barrier at maturity.

Top agents, issuers

The top agent last week was UBS with $66 million in 76 deals, or 20.7% of the total. It was followed by Morgan Stanley and JPMorgan.

Barclays Bank plc was the No. 1 issuer for the week, bringing to market a notional amount of $54 million in 16 deals.

JPMorgan Chase Financial Co. LLC was the top issuer the week before. It still leads for the year with $1.25 billion in 425 deals, or 15.3% of the year-to-date notional volume.

“The market is pricing in a rate cut. How things have changed in just a few months.” – Jason Barsema, co-founder and president of Halo Investing, Inc.

“It’s hard to see whether volatility is going to come back until we get into the earnings season next month. Right now, I don’t see the market moving out of its narrow range.” – David Chojnacki, portfolio manager of Sabretooth Advisors

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