Structured products weekly tally $543 million on flurry of bearish notes issuance

By Emma Trincal

New York, April 18 – Structured products agents priced $543 million in 114 deals in the week ended Friday, which included at least five bearish note offerings totaling $106 million, according to preliminary data compiled by Prospect News.

For the year through April 14, volume was $22.62 billion issued in 4,445 deals, a decline of 18.6% from last year’s $27.78 billion sold in 8,398 offerings.

Volume for the first half of April is weak so far, but figures will be revised upward due to gaps between pricing and regulatory filings. Agents have priced $1.26 billion this month through April 14, a 56.3% drop from March. This is reflected in the decline in the number of block trades this month with only one deal in excess of $50 million compared to 12 during the same period in March.

One source of this discrepancy can be found in the flood of rate-linked notes that hit the market last month and the fact that they price in larger sizes than their equity counterparts. The first half of March saw the pricing of 12 rate offerings totaling $755 million compared to only two deals this month for $18 million.

Bear party

Last week was unusually bearish: a fifth of total sales came from bearish notes.

Five issuers priced nine-month bearish capped buffer GEARS deals tied to the S&P 500 index. All priced on April 11.

At maturity, the gain is 3x the decline of the index, subject to a maximum return, which varied.

If the index finishes flat or positive, investors enjoy the protection of an 8% buffer. This buffer size was identical in all deals.

UBS was the agent for those deals, which all carried the same fee of 0.75%.

Top five

Citigroup Global Markets Holdings Inc. priced the largest one of those bear deals for $42.29 million with a 24.84% cap, followed by Royal Bank of Canada’s $18.53 capped at 23.03%; JPMorgan Chase Financial Co. LLC issued $18.41 million with a 22.55% cap; GS Finance Corp.’s $18.39 million notes were capped at 22.56%; and UBS AG, London Branch priced the smallest offering for $8.04 million with a 23.1% maximum return.

More deals from that template may still be in the process of being priced and filed with the Securities and Exchange Commission.

The cap varied. The largest sized deal was the one with the highest cap, a structurer noted.

“While there is not a major difference between those caps, they priced differently based on the funding rates of the issuers since everything else from the structure, the fee and the trade date were the same,” he said.

Two days later, Royal Bank of Canada and GS Finance priced other bearish notes but via different structures and in much smaller sizes, at less than $2 million.

Other larger offerings last week included Canadian Imperial Bank of Commerce’s $38.28 million of three-year digital notes on the S&P 500 index. Investors earn a digital payout of 30.1% if the index finishes above 83% of the index’s initial level and lose one-to-one beyond the 17% buffer.

Indexes playing solo

Equity indexes last week accounted for 77% of the total with $421 million in 72 deals. Two thirds of the volume of those notes came from single-index-linked notes with the other third consisting of worst-of deals. The pendulum between the use of single versus multiple underliers vary according to many different factors, including volatility, the type of structure and the issuer, the structurer said.

For instance, autocallable contingent coupon notes are almost always built on worst-of, according to the data. Some issuers, for instance Barclays Bank plc, sell worst-of notes more often than others. Leveraged motes tend to be linked to one index only.

Volatility has been low for most of this year, the structurer noted. If issuers are pricing fewer worst-of in this environment, such trend, if verified, would be counterintuitive.

“Whenever volatility is extremely low, issuers are loading up on different indices. We used to see a lot of worst-of on four indices. It gets expensive for banks to hedge all four because they have to hedge the correlation risk,” said Jerry Verseput, president of Veripax Wealth Management.

Depressed VIX

On Wednesday the VIX hit a 52-week low at 16.34, which is below its historical average of 20. For some contrarians, depressed volatility levels are not a good sign for the stock market.

For structurers, the low VIX means less premium for the pricing of short-volatility income notes. This has been the trend this year with the Phoenix autocall tally dropping 30% to $8.72 billion this year from $12.4 billion last year.

Myriad other factors may be at play, the structurer said.

He mentioned one:

“The VIX is low, but correlations are pretty high at the moment, which doesn’t make worst-of pricing all that efficient,” he said.

“With worst-of payouts, issuers can extract more premium and offer higher coupons as long as the correlations are negative or low. When they’re high, you’re not getting much.

“I was recently trying to price an autocall on the Euro Stoxx and the Nasdaq. I was getting a 10.5% coupon. When I took out the Euro Stoxx, I lost only 40 basis points.

“Why take the additional risk of a worst-of when you can get pretty much the same coupon on a single index?”

Interest rate moves play a relatively small part in this, he added.

“The interest rates influence the spread you get over the risk-free rate. In my example, if the risk-free rate is 5%, I can get an additional 5% from risk. That difference doesn’t explain the low gap of 40 bps between my two pricing examples,” he said.

Uncertainties

What is even harder to explain is why volatility is so low at a time when geopolitical tensions, uncertainties around the Fed’s tightening effort and recession fears are major concerns among investors.

“Maybe we still enjoy a little bit of the Fed put. Each time there is a problem, the Fed and the central banks systematically step in like they did last month to stop the bank run,” he said.

But the quiet market as the earnings season just kicked off puzzled him.

“There is always additional volatility in the market during earnings season to reflect the uncertainty. The fact that the VIX is below 17 is really bizarre. I can’t explain this,” he said.

The VIX spiked during the short-lived regional bank crisis hitting an intraday high of 30.81 on March 13, he noted. No one knows if the crisis is over, but the calm returned to the market. In just about a month, the S&P 500 index rose 9%.

Issuers’ pie

Last month’s bank run raised some questions among advisers who buy structured notes.

One of them said he has paid more attention to credit risk.

“I’m not alone,” he said.

He also reflected on the role of issuing banks in this market.

“I wonder if the big banks are going to need to raise more capital now that tons of depositors have moved their money from the regional banks,” he said.

“Issuing structured notes is definitely a way for them to raise money. They have a competitive edge over regional banks in that market. But if they don’t need money, they may not offer very attractive terms.”

Many observers of the structured notes industry wish the market would include more issuers. The penetration of four Canadian banks (CIBC, Scotia Bank, RBC and TD Bank) has provided more diversification. But what about diversification by size, this adviser asked.

“The big banks dominate our industry.

“I have yet to see regional banks issuing structured notes. I don’t even know if they could do it from a regulatory standpoint. But I would love to see them getting together and compete with the big issuers. After all, if you can buy a one-year CD through your local bank, why couldn’t you buy a one-year note?”

The top agent last week was UBS with $131 million in 21 deals, or 24.16% of the total.

It was followed by JPMorgan and Goldman Sachs.

JPMorgan Chase Financial was the No. 1 issuer with 26 offerings totaling $97 million, a 17.8% share.

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