Structured products agents price $283 million for week amid virus-induced volatility, rate cut

By Emma Trincal

New York, March 11 – Agents sold $283 million of structured notes in 80 deals last week as the coronavirus outbreak continued to fuel extreme volatility for the second week in a row, according to preliminary data compiled by Prospect News.

The previous week had already seen a severe correction with the S&P 500 index plunging 13% from its Feb. 19 all-time high. The difference was that last week ended slightly positive. Yet, investors still had to endure daily thousand-point swings in the Dow Jones industrial average.

The S&P 500 index finished up 0.6% last week, closing a week of intense volatility as coronavirus cases continued to rise globally.

Record week for sales

“It’s a crazy market,” said Andrew Valentine Pool, main trader at Regatta Research & Money Management.

Interestingly enough, revised data for the last week of February, which saw five days of consecutive stock price declines in what turned out to be the worst week in percentage decline since 2008, revealed a record weekly tally for structured notes issuance.

February ended with the best notional sales amount since 2004, followed very closely by the previous week, ended Feb. 21, with $3.40 billion.

One has to go back to the last week of January 2015 ($3.14 billion) and the last week of February 2008 ($2.97 billion) to find comparable levels of issuance strength.

The year-to-date figures are also strong. Sales of registered structured notes (excluding exchange-traded notes and Libor-based lightly structured products) grew by 88.4% to $13.77 billion this year through March 6 from $7.31 billion during the same time last year.

Meanwhile the number of deals is up 55.2% to 3,674 from 2,322.

That such strong issuance levels happened to be seen in the midst of a nearly unprecedented stock market correction came as a surprise for some.

“90% volume pick up. It’s huge. I had no idea,” said Pool.

Weaker Fed put

On Tuesday, the Federal Reserve cut interest rates by 50 basis points in an emergency move. But the market rally, which followed the next day, was short-lived.

“It’s not a vaccine. It’s not going to open schools back up or alleviate quarantines,” said Liz Ann Sonders, chief investment strategist at Charles Schwab in a research note.

Pool agreed.

“When it comes to Covid-19, the Fed has very limited ways to influence the public,” he said.

“The 50-basis points rate cut is not going to increase the number of people who go on a cruise ship, it’s not going to make people want to fly in a plane, prevent schools from closing and stop events from happening.

“If this keeps up for another quarter, the less aggressive investor will get scared.”

Low yields

A flight to safety pushed the 10-year Treasury yield below 0.70% while crude oil prices tumbled.

Investors continued to worry about the economic impact of the coronavirus outbreak as the closing of factories and quarantines may disrupt global supply and demand.

A robust job report on Friday did not prevent selling pressures on that day despite a last-minute rally.

For Pool, the strong issuance pace of structured notes seen over the past two weeks is probably temporary.

“This continuous market turmoil will decrease volume,” he said.

“Investors are a bit concerned about this market and won’t be as aggressive. They may pull some of their money out.”

Autocalls, worst-of

As it has been the trend recently, investors rushed into autocallable notes. Worst-of deals amounted to 38% of total sales with $108 million in eight deals, all index-based.

As volatility skyrocketed, selling volatility to price compelling coupons made sense for many. Investors were able to find attractive terms on indexes without having to search for individual stocks.

Volume for equity indexes represented 74% of total flow while single stocks made for only 15% of it.

Leveraged notes issuance was very weak.

Pool is not convinced that the market will remain dominated by autocall products for a prolonged time.

“You won’t have zero volume in autocalls. There will always be demand for those products. But attitude toward risk may change in this more uncertain environment,” he said.

Short volatility bets may continue to be in vogue for some time until aversion for risk catches on with investors.

Risk off

“In my opinion, clients investing in structured notes are in for the gains or the hedge. They like to get either return enhancement or full principal-protection,” he said.

Principal-protection will become increasingly hard to price and the bullish momentum may no longer be the main driver, he added.

“So, they may stop purchasing structured notes altogether at least for now.

“Maybe a number of them will want to stay neutral or move into cash for the time being.”

But Pool is not overly pessimistic about the long-term effects of the virus outbreak.

“We will have another three to six months of this issue. I think by that time the spread will begin to cease. It will work its way through the system,” he said.

Carl Kunhardt, wealth advisor at Quest Capital Management, also expressed relative optimism.

“There are so many opportunities in this environment. The 10-year is at 77 bps. Refinance your mortgage and use the money you’re saving as equity,” he said.

“There are a lot of silver linings.

“But everybody is so obsessed with the virus. Just because the traders in New York are in a panic doesn’t mean the rest of the country is.”

Full, partial protection

After the Fed cut rates, the 10-year Treasury yield dropped below 1% for the first time ever. Meanwhile, investors rushing into Treasuries in a bid for safety contributed to push rates lower. On Monday earlier this week, the yield fell to 47 bps.

When issuers’ funding rates are lower, the economics of pricing principal-protection out of a zero-coupon bond become very difficult.

Some worry that further cuts by the Fed will bring rates into negative territory or at least much lower.

“Interest rates are at record lows. It will go lower as the year progresses on,” said Pool.

“Therefore, there will be less options. Principal-protection solutions for clients who want to be safe will not be available to them.”

Others envision a greater demand for products offering at least a degree of downside protection regardless of whether the type of note is a growth or income product.

“The impact of the coronavirus seems to encourage people to look for some kind of downside protection. From that perspective, buffers and barrier products are attractive,” said Clemens Kownatzki, independent options trader.

Top deals

For the first week of the month, two deals stood out for their size.

GS Finance Corp. priced a large digital note offering and the top one in $60.03 million of 14-month index-linked notes tied to the Nasdaq-100 index.

The structure offers a so-called “in-the-money” digital option, allowing for gains within a tight band of index decline.

If the index return is greater than or equal to 90% of its initial level, the payout at maturity will be par plus 10.07%.

If the index return is below negative 10%, investors will lose 1.1111% for every 1% decline of the index beyond 10%.

Barclays, GS Finance

The second largest deal came from Barclays Bank plc, which priced $51.14 million of two-year autocallable contingent coupon note on the S&P 500 index. UBS is the agent.

The notes will pay a contingent quarterly coupon at an annual rate of 7.38% based on a 75% coupon barrier. After six months, the notes will be called if the index is above its initial level on any quarterly observation date.

The repayment barrier at maturity is 75% of the initial price.

The third deal was a worst-of on indexes brought to market by GS Finance, which sold $21.06 million of contingent income callable securities due Sept. 9, 2022 linked to the least performing of the Euro Stoxx 50 index, the S&P 500 index and the Russell 2000 index.

Each quarter, the notes pay a contingent coupon at the rate of 9.5% per year if each index closes at or above its coupon barrier, 70% of its initial level, on the coupon observation date that quarter.

The notes are callable at par plus the coupon, if any, on any quarterly coupon payment date other than the final one.

The barrier at maturity for the least-performing index from its initial level is 70%.

Morgan Stanley is the dealer.

UBS was the top agent with 45.3% of the volume in 69 deals totaling $128 million.

It was followed by Goldman Sachs and Morgan Stanley.

GS Finance was the No. 1 issuer last week with $103 million in four deals, or 36.4% of the total.

For the year, Barclays Bank is the top issuer with $2.126 billion in 377 offerings, a 15.44% 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.