Structured products issuance volume improves, leverage regains favor as market hits new highs

By Emma Trincal

New York, July 27 – Volume picked up in the third week of July, buoyed by a post-Brexit rally, which reignited optimism among the bulls as evidenced by a stronger bid on leveraged return note offerings.

Agents last week priced $278 million in 97 deals, a nearly 10% increase from the previous week, according to data compiled by Prospect News.

July results

For the month, sales amounted to $1.53 billion as of July 22, a 37% increase from the same time last month.

While encouraging, the sharp spike for the monthly volume needs to be put into the context of BofA Merrill Lynch’s decision to halt its month-end pricing in June in anticipation of the potentially negative impact of the U.K. vote to leave the European Union, or “Brexit,” on the markets.

This agent priced nearly $700 million in the first week of July rather than in the last week of June as it normally does, causing volume for this early part of the month to swell.

For the year, sales remain down just below the 25% mark to $19.6 billion from $26 billion last year.

Market rally

The U.K. vote led to a sharp sell-off for a couple of days followed by a solid rally. Over the last month, the S&P 500 index has gained more than 8%. Bullish products as a result have reemerged last week.

Leveraged notes for instance made for 43.5% of the total, a sign that bulls are back in charge, according to sources.

They said that investors’ confidence has improved as the market has decisively recovered from “Brexit.”

Several U.S. benchmarks hit new record highs last week while improved U.S. economic data helped. This post-Brexit rally has made some investors more optimistic while others remain cautious given the length of the current bull market, which is more than seven years old.

Volatility

“My big concern if this bull market continues is that volatility will drop further. You could see less volume because of that,” a structurer said.

“Selling volatility at this point in time has become increasingly challenging unless you look for some especially volatile stocks.

At the same time, investors continue to chase yield and income products, in particular autocallable reverse convertibles remain in high demand. But this structurer said it is probably a mistake.

“Buying volatility is what investors should do. Leverage is much less expensive.”

That’s because leveraged structures require purchasing call options whose cost declines when volatility decreases.

“We’re seeing new highs in the S&P. There is no recession in sight. I don’t see why it shouldn’t continue.

“U.S. growth should pick up, which should lead to higher stock prices.”

The continued dovish policies of central banks, especially in the euro zone and in Japan, were another bullish sign, he said.

“Barring a major terrorist attack – and even that may not stop the rally...it would merely create new buying opportunities for a short time – I see continued upside for the next three months.

“In that case, why not use the low volatility to buy leveraged capped notes or even with no cap to transfer dividends into appreciation?”

Citigroup, RBC

The top two deals last week were leveraged buffered notes. Among the deals on the top of the list, some came in pairs of very similar products. It was the case for the top two: while issued by two different banks, they presented nearly identical structures.

Citigroup Global Markets Holdings Inc. priced $42.21 million of 0% buffered notes due Oct. 3, 2018 linked to the S&P 500 index. The leverage was two-times up to a 20% cap. There was a 10% geared buffer on the downside with a 1.11 multiple beyond 10%.

Royal Bank of Canada brought to market notes maturing two weeks before, also tied to the S&P 500 index. The upside leverage factor was 1.6, the cap 27.52% and the geared buffer 12.5% with a 1.1429 multiple.

“These are pretty standard structures, but the two deals have a lot in common,” said a sellsider, pointing to the maturities, underlying index, leveraged capped upside and the geared buffer.

“It could be a big client trying to diversify the credit,” he said.

“Banks don’t pay much on a two-year. There’s not a big difference in pricing between the two banks. Credit spreads aren’t very wide. It makes sense to split the risk between two names in two different trades.”

Momentum Builder

Goldman Sachs priced the third deal, which offered full principal protection via the exposure to one of the firm’s most popular proprietary indexes.

GS Finance Corp., the issuing arm of Goldman Sachs, priced $17.65 million of four-year notes linked to the GS Momentum Builder Multi-Asset 5S ER index.

The structure offered 1.43 times leverage, had no cap and provided full downside protection.

The underlying index offers diversified exposure to price momentum of several asset classes using 14 different exchange-traded funds based on a methodology developed by Goldman Sachs.

The Momentum Builder underlying is a very popular one in the U.S. structured products market.

The bank also uses it for some of its structured certificates of deposits.

So far this year, the GS Momentum Builder Multi-Asset 5S ER index has been employed in 46 offerings totaling $153 million, according to the data.

“Rates are very low, and it’s hard to price full principal-protection,” the sellsider said.

“This index controls volatility, which cheapens the price of the call options. If you had to structure 1.43 times leverage on the S&P options it would probably cost you three times that.

“At the same time, this index has not shown a very high performance. It’s about 5% a year since 2013.

“One might argue that such low volatility might not require full capital protection. But that’s why you use the leverage. As long as you know that, as long as it’s fully clear and transparent, this deal is totally fine,” he said.

Oil picks

Finally Bank of Montreal brought to market a pair of tracker notes linked to a basket of oil stocks selected by Raymond James.

The first one was $15.95 million of two-year notes linked to Raymond James oil stock picks, a basket of 14 oil stocks.

Investors would receive less than par if the basket level percentage was less than 103.36%.

A nearly identical deal priced for $7.33 million on the same day. The basket level percentage breakeven was 102.83%.

The top agent last week was JPMorgan with 19 deals totaling $61 million, or 22% of the market. It was followed by Royal Bank of Canada and Goldman Sachs.

“My big concern if this bull market continues is that volatility will drop further. You could see less volume because of that.” – A structurer

© 2015 Prospect News.
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