Structured products volume slow in first week of May as expected; autocallable deals most favored

By Emma Trincal

New York, May 11 – Agents priced $269 million of structured notes during the week ended Friday. The total number of deals, which was 57, was limited. Sizes were modest with the top offering at $38 million, according to data compiled by Prospect News.

Each first week of any given month is slow based on a firm’s monthly calendar cycles.

Last week’s issuance volume was exactly in line with or normal compared to recent months. Sales in the first week of March and April amounted to $267 million and $258 million, respectively.

The earlier part of the year showed a different pattern, which is also consistent with previous years.

January and February generated $581 million and $455 million in sales, respectively, according to the data.

More preoccupying for sellsiders is the volume decline year to date by nearly a quarter versus last year. Agents this year have priced $13.10 billion as of May 6 versus $17.18 billion for the same period last year, a 24.6% decline.

Meanwhile, the number of deals has dropped 15% to 2,621 from 3,082, the data showed.

But not every firm is feeling the pinch.

“We don’t see any downturn this year in our activity. We had quite a good volume actually,” said a structurer.

The magnitude of the decline varies from shop to shop, sources said, based on the products being sold and the types of buyers.

“It’s definitely not as good as last year. Yes 25% down, that’s the same number I’ve been hearing. We’re down, but not like that. It’s more like 10%,” said a sellsider.

Amid mixed earnings results, stocks continued to trade lower last week led by a continued slide in the technology sector and a disappointing jobs report.

The S&P 500 index has only gained 1.5% for the year. After a correction earlier in the year, followed by a two-month rally, the market is again making up or down moves with no clear pattern.

Autocallables

It may be one of the reasons behind an increased demand for autocallable reverse convertible notes, some said, as investors expect limited upside. Moreover, the quest for yield remains strong.

This type of trade reached an exceptionally high volume last week, making for 43% of the total, or $115 million in 28 deals. For the year to date, autocallable reverse convertibles represent on average 18% of total volume, according to the data.

The bulk of these deals – larger in size but fewer in number – were worst-of structures based on indexes. The rest were small-size deals, ranging from $100,000 to $8.8 million. They were linked to single-stocks.

All products offered a contingent coupon as opposed to a fixed coupon.

For fixed coupon deals – or traditional reverse convertibles with no autocall – supply was limited to less than $4 million in five offerings.

“We don’t do as much reverse convertible or Phoenix type deals on single stocks anymore,” the sellsider said.

The increased volatility in the markets has made investors more risk-averse when it comes to stock-picking, he noted.

“Primarily it’s typically linked to broad-based indices worst-of... except that we don’t call them worst-of anymore but lesser-performing. It sounds a little less harsh.”

Top deal

The top deal of this type and the second to price last week was brought to market by UBS AG, London Branch. The firm issued $20.32 million of trigger callable contingent yield notes due Aug. 11, 2020 linked to the worst performing of the MSCI EAFE index, the S&P 500 index and the Russell 2000 index.

Each quarter, the notes would pay a contingent coupon at an annual rate of 9% if each index closed at or above 60% of its initial level on the observation date for that quarter.

The notes would be callable at par on any quarterly observation date. The call was discretionary.

The final barrier was at 60% of the initial price for the worst-performing index. If breached, investors would lose 1% for every 1% that the least-performing index’s final level was below its initial level.

Getting high yield

The structurer said that he also priced a fair amount of worst-of products linked to equity indexes.

“When you do a worst-of you take an additional risk, which is correlation. We’d rather stick to indices rather than Apple, Microsoft or Google. You have no idiosyncratic correlation but you still have enough value for the coupon to remain interesting,” he said.

Investors looking for attractive income are bidding on contingent coupon autocallable notes, he said. A special feature makes the contingency of the coupon a little bit more acceptable for income investors, he explained.

“We like autocalls contingent coupon deals. They have a feature called memory, which means that at some point the coupon is not paid but you can get it later. After the stock has recovered all the coupons you’ve missed previously are now paid to you. It’s not a guaranteed coupon, so you get a higher premium. But the memory feature is very popular.”

The contingency of the coupon, the autocallable option and the worst-of payout provide all the right ingredients for higher coupons, he said.

“We do an autocall. If we’re right, you get called and you had a higher coupon,” he said. “You had to pay a fee and you have the reinvestment risk, but at least you get compensated with a solid premium.

“If we’re wrong, the product sticks to the portfolio. The bank doesn’t get to make a new product, doesn’t earn new fees. But the investor may get more income at a competitive rate.”

Worst-of

Structuring worst-of deals on indexes rather than on single stocks is more appealing for investors as it lowers the risk. For issuers, it also helps pricing, he said.

“We stick to the major indices where we can find the right volatility spreads so it costs less,” he said.

“We use European style barriers so we avoid flash crashes.”

A European barrier is observed at maturity as opposed to American-style barriers usually observed on any trading day. As a result European barriers are less risky.

“It lowers the coupon but at the same time, we know that the barrier is not going to be breached that easily.”

Issuers are able to price those products in the current market characterized by rising volatility levels. Using benchmarks enable structurers to strike the right balance between making the economics of the deal attractive and cost-efficient.

“We need the volatility. But when there’s too much volatility your cost for structuring the product is prohibitive,” he said.

Leverage

Leveraged notes are also cost-sensitive when volatility rises. But depending on the components of the deal, volatility spikes can also make the structure more attractive by offering lower barriers or bigger buffers for instance, he said.

Leveraged notes with a barrier or a buffer made for 30% of the volume last week, totaling $81 million in seven offerings. The first and the third deals of the week were leverage buffered notes.

GS Finance Corp. priced $38.13 million of three-year leveraged buffered notes tied to the S&P 500 index.

The notes were guaranteed by Goldman Sachs Group, Inc.

The leverage factor was two and the cap 23.3%. There was a 35% geared buffer on the downside with a 1.5385 rate.

HSBC USA Inc. priced $19.84 million of two-year leveraged buffered notes linked to the S&P 500 index. The payout at maturity was par plus 150% of any index gain, up to a 24.9% cap. The 15% downside buffer was geared at a rate of 1.1765.

The top agent was Goldman Sachs with $71 million in six deals, or 26.3% of the total. It was followed by JPMorgan and UBS.

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