April debuts slowly with $138 million of structured products issuance despite stock market rally

By Emma Trincal

New York, April 10 – The discrepancy between the stock market and structured notes issuance continued to be visible last week. On the equity side, investors, encouraged by renewed optimism about trade talks, a dovish Federal Reserve and a strong job report on Friday, pushed the benchmarks close to their record highs of September.

The S&P 500 index rose 2.1% on the week to 2,892.74, or 48 points short of its record on Sept. 21.

On the structured products front, however, the month started on a weak note with $138 million in 85 deals.

Even the top deal was lower than the $20 million mark, according to data compiled by Prospect News.

And yet, the bull market went on unabated. The S&P 500 has gained 15.4% for the year through Friday.

This goes hand in hand with a record low CBOE Volatility index. The VIX traded below 13.75% last week, which seems to suggest that investors have regained confidence in the rally and the strength of the economy.

But sellers of structured notes are not convinced that their client’s bullishness is established on solid ground.

The shadow of Christmas

“What I hear from investors is that the end of last year really caused a great deal of concern because of the pullback,” said Andrew Valentine Pool, main trader at Regatta Research & Money Management.

“That led a lot of people to realize they were more risk-averse than they thought.

“Sure, the stock market is going up right now and at a fast pace. But few people trust this rally as they would have trusted it last year.

“December had an impact on sentiment.”

The stock market plummeted on Christmas Eve, flirting with a bear market compared to September all-time highs.

Leveraged with caution

One sign of this “risk aversion” was the continued prevalence of deals that offer some protection.

Last week, all leveraged notes came with a buffer or barrier and none was unprotected, the data showed, which was unusual. Even this year, marked by a decline of risk-taking, leverage with no buffer and no barrier still accounts for one out of four leveraged products on average, the data showed.

“People are pushing for protection. We’re seeing that among our clients,” said Pool.

“We try to stay away from the S&P 500 because we think it’s overvalued. But we did a three-year deal on it this month only because it had a 15% buffer. The upside participation was 300% and the cap was at around 24%. This was in line with our low return expectations and our investors’ demand for protection.”

Job report

Last Friday’s labor report showed that the U.S. economy added 196,000 jobs in March while the year-over-year wage growth was contained to 0.1%. The market rallied. The low inflation seemed to comfort the notion that the Fed will refrain from hiking rates and that it may even turn accomodative again. Meanwhile the fears of a recession, recently triggered by an inverted yield curve, have eased.

Pool said that these positive indicators are not enough to rule out a possible recession.

“You need to look at a number of factors leading to a recession, not just employment.”

40% decline

The year-to-date issuance volume continued to show a worrisome decline.

Sales from the beginning of the year through April 5 amounted to $10.64 billion, a 40% drop from $17.72 billion the year before.

There were 26 offerings in excess of $50 million during that period last year, exactly twice more than this year.

A sellsider agreed that the “December effect” may partially be to blame. “It takes time for people to notice that the sell-off is over. It’s particularly true for the average structured products buyer, who tends to be prudent,” he said.

“When the market falls fairly fast like it did in December, they don’t necessarily feel relieved right away. Instead, they expect more bad news.”

Unfair comparison

This sellsider advanced another explanation.

“Too many banks compare this year’s business with last year’s. But 2018 was a record year. The first quarter of last year was exceptional,” he said.

Indeed, the first quarter of 2018 saw the pricing of $17.2 billion, a 22.6% increase from the previous year.

The year 2017 was the second-best year with $52 billion, according to data compiled by Prospect News going back to 2007.

But last year’s $56.84 billion beat that record by 10%.

“If you compare 2019 to other years, you’ll see that the situation is not as bad as it seems,” he said.

“By the way, we did strike a lot of structures. I can assure you that volume is not down quarter-to-quarter at our bank.”

Twelve-month trailing totals attenuated the year-to-date’s bleak picture. They revealed a 10.2% decline to $49.53 billion from $55.40 billion in the past 12 months versus the same period a year earlier.

Volatility

Volatility is sometimes invoked as one of the culprits for what remains a disappointing year so far. After all, shorting volatility is what delivers good coupons in autocallables. The option premium can be used to offer other favorable terms such as buffers, for instance.

Whether the low volatility is a significant factor behind the volume drop remained to be seen though.

“It certainly matters. But I don’t think it’s as important as many people think,” the sellsider said.

“Even if volatility is at record lows, if you’re used to sell volatility, you continue to sell volatility. It’s the force of habit.

“Also, low volatility encourages investors to enter the market. It means that people perceive risk as low.”

The low volatility may even boost issuance volume in other ways.

“The market is up. Every autocall is going to be auto called. Investors need to reinvest. And they do.

Top, small deal

Last week’s top deal was an 18-month buffered digital note on the Russell 2000 index issued by Citigroup Global Markets Holdings Inc. for $19.16 million.

If the index finishes above 85% of its initial level, the payout will be par plus 9.45%.

Otherwise, investors will lose 1.1765% for every 1% decline beyond 15%.

Unusual buffer

Recently, Citigroup issued a small deal for $3 million, which was worth mentioning for its downside structure.

The three-year market-linked notes linked to the Euro Stoxx 50 index will pay at maturity the greater of the index return and the 19% fixed return if the index is flat or up. If it falls by up to 30%, the payout will be par.

Otherwise, investors will receive the minimum payment of 90% of par. In essence, a “breach” of the buffer will cause investors to lose a fixed amount of principal of 10%, which would be the worst-case scenario.

Cap and coupon

Another intriguing structure, which settled last week, came from HSBC USA Inc. in a $710,000 deal of buffered Acceleration Market Participation Securities tied to the S&P 500 index. The double leverage exposure is capped at a modest level of 25.5% given the five-year tenor. However, investors benefit from the payment at maturity of a fixed “coupon” of 10%, whose effect is to raise the cap to 35.5% while guaranteeing a minimum return of 10%. In addition, noteholders benefit from a 20% downside buffer.

The top agent last week was UBS with 39 deals totaling $34 million, or 24.71% of the total volume.

It was followed by JPMorgan and Citigroup.

Citigroup Global Markets Holdings was the No. 1 issuer with $33 million in five deals, a 24.14% share.

For the year to date, JPMorgan Chase Financial Co. LLC remained the top issuer with $1.52 billion, a 14.27% share in 552 deals.

“What I hear from investors is that the end of last year really caused a great deal of concern because of the pullback. That led a lot of people to realize they were more risk-averse than they thought. Sure, the stock market is going up right now and at a fast pace. But few people trust this rally as they would have trusted it last year.” – Andrew Valentine Pool, main trader at Regatta Research & Money Management

“Too many banks compare this year’s business with last year’s. But 2018 was a record year. The first quarter of last year was exceptional.” – A sellsider

© 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.