Volume still strong, up 41% for the year, as competition, technology increase deal count

By Emma Trincal

New York, June 28 – It is not news: so far this year in structured products is much better than last.

Agents have sold $23.8 billion of deals through June 21, a 40.75% increase from $16.91 billion for the comparable period of last year, according to data compiled by Prospect News.

If anything, those figures are subject to be updated on the upside. That’s because not all deals which priced last week had necessarily settled or been filed on the Securities and Exchange Commission by press time.

As the monthly calendar ends this week ahead of the July 4 weekend, next week should offer a more detailed picture.

Sources pointed to the bull market as a source of growth.

But some developments within the distribution channels are also playing a significant role, notably the increase in smaller deals and a recent effort to launch technology platforms to reach new markets.

Equity on steroids

Among the factors contributing to the increase, the first is the lackluster year of 2016. For this year however, the story is the market.

“Last year we had the Brexit. Merrill took one month off. That was the infamous hiccup to the business,” a market participant said.

“The Trump effect has also been setting records day after day on the indices.

“A lot of that growth is the bull market. It really comes from the equity side.”

Volume is always dominated by equity in any given year. Equity-related sales amounted to 92% of the volume last year through June 21. The market share is 89% this year.

But in terms of growth, equity sales have indeed jumped in 2017, up 36.5% to $21.15 billion from $15.50 billion a year ago, the data showed. This is partly due to a pronounced decline observed last year versus 2015, a year which recorded $19.62 billion in equity sales.

Prospect News counts as “equity” all structured notes linked to equity indexes, single-stocks or baskets of stocks.

Market-driven growth

The correlation between issuance volume growth and the spike in equity-based notes is for some a cause for concern.

“People keep on buying equity at these levels and the market keeps moving up. And yet fundamentals are just not there,” the participant said.

Signs of a possible correction abound but investors are still confident.

“Most indices are at their all-time high. The stock market isn’t cheap. Unfortunately, people tend to buy the strength and sell the weakness. Investors are trying to catch the tail end of the train,” an industry source said.

Pricing conditions

This source said that it is cheerful sentiment enticing investors to invest that is causing the growth in structured products rather than market conditions.

“We’re doing much better than last year. But we were not falling down the cliff last year. My point is: what slowed the market down a year ago – low interest rates and low volatility – is still here today. It hasn’t changed,” he said.

“We know that the best conditions to price products require high volatility and higher rates. The rise in rates has been in the short end of the curve but the curve is flattening and short-term rates are still historically low.

You can forget about those zero-coupon bonds that cost fewer dollars when rates are high.”

He was referring to principal-protected notes whose economics depend a lot on higher interest rates.

Meanwhile volatility continues to be at multi-year low. Last week, the CBOE VIX index fell below 10%, one of its lowest levels for the year after a drop to 9.75% early this month.

“I don’t think a low vol is the best recipe for putting together structured products so I find it a little bit surprising that volume would be so high,”

It is possible, he added, that the market is as highly complacent as the volatility levels suggest.

New leaders

Second growth factor: some agents have made a push in the market this year.

Firms such as JPMorgan, Morgan Stanley and UBS have expanded their reach.

While JPMorgan’s volume so far is up 39%, and Morgan Stanley has grown 114% and UBS’ jump by 107% is even more remarkable given how this firm achieved this result.

UBS has nearly tripled the number of deals it priced. The total is 1,836 so far this year versus 615 for the same period of last year. JPMorgan has increased its deals by 21% from 831 a year ago and Morgan Stanley by 74% to 330 from 190.

In volume UBS has added nearly $1 billion in sales, growing to $1.79 billion from $864 million.

UBS, platforms

“UBS is putting out significant numbers,” the market participant said.

The trend is representative of a bigger distribution advance in the industry, he added, namely the development of online platforms as a mean to facilitate the distribution of many more deals even though they are smaller in size.

The number of deals in the overall market has climbed by more than two-thirds to 6,133 from 3,652 last year.

Size may be smaller, as shown by the figures, but distribution has more and more become a number’s game.

“UBS was one of the early adopters of the online distribution model. Maybe that’s it. Maybe that’s part of why we have such a strong growth this year,” the market participant said.

UBS is not alone. Goldman Sachs launched its own platform called Simon last year. JPMorgan was in the process of developing its own. It’s unsure whether the project has been finalized or interrupted, according to sources.

“Online platforms have made it easier to make smaller deals,” he said.

“You may be able to do a lot more smaller on-off customized deals using the platform.”

Last week

Agents last week priced $350 million in 120 deals in the week ended June 23, according to the data. These numbers are very likely to be revised upward due to filing delays.

As has been the case this whole year, autocallable contingent coupon notes constitute more than the majority of the weekly volume. This trend ceases when Merrill Lynch prices its own calendar deals on the final week of each month. The large agent tends to bring to market an overwhelming dollar amount of leveraged note offerings.

Autocallable contingent coupon notes made for $189 million last week in 79 deals, or 54% of the total issued.

“Everybody expected rates to be higher this year. This is not what happened. There is this sense that rates are not going to be up,” the market participant said.

The flattening of the yield curve raises some issues as well. It indicates that growth expectations from the bond market perspective differ from the more sanguine stock market assessment as indicated by rising equity prices and falling implied volatility.

The 10-year note yield was at 2.22% on Wednesday versus 2.50% at the start of the year.

10-year GS

GS Finance Corp.’s $18.35 million of 10-year trigger autocallable contingent yield notes linked to the S&P 500 index and the Euro Stoxx 50 index was unusually long in duration for a worst of contingent coupon deal, sources noted.

It was the top deal by dollar amount, according to the preliminary data.

The notes pay a contingent coupon of 7.13% per year on a quarterly basis if the worst-performing index is at or above a 70% coupon barrier. After one year, the notes will be automatically called if the worst performing index finishes above its initial price. There is a 50% barrier at maturity.

“It’s a longer maturity. But there is the callability, which is to the benefit of the issuer while it’s certainly to the benefit of the investor to have this 50% barrier at maturity or even the 70% coupon barrier,” the industry source said.

Buffered worst of

Coming next was Wells Fargo & Co.’s $16.16 million of three-year leveraged buffered notes linked to a basket of exchange-traded funds.

The underlying basket consists of the SPDR S&P 500 ETF trust with a 50% weight, iShares Russell 2000 ETF with a 25% weight and the iShares MSCI EAFE ETF with a 25% weight

The upside is levered at a rate of 1.16 and uncapped. The downside features a 10% buffer.

“This is a bullish trade. A 10% buffer isn’t much when you’re very close to all-time highs at least for two of these indices,” this source said, alluding to the S&P 500 index and the Russell 2000.

The top agent last week was JPMorgan with $90 million priced in 18 deals or 27% of the total. It was followed by UBS and Morgan Stanley.

The top issuer was JPMorgan Chase Financial Co. with $77 million in 15 deals.

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