Structured products issuance rises to $472 million for week, helped by a $232 million convertible

By Emma Trincal

New York, April 25 – Structured products issuance jumped last week courtesy of a big convertible deal pushing notional to $472 million in just 82 deals for the third week of the month, according to preliminary data compiled by Prospect News.

Deutsche Bank AG, London Branch priced $231.75 million of five-year cash-settled equity-linked notes tied to JPMorgan Chase & Co.

At maturity, investors will receive a cash payment based on the final price of JPMorgan stock with a 2.91% maximum loss due to the premium price of 103.

One does not come alone. A second synthetic convertible issue followed albeit smaller in size. JPMorgan Chase Financial Co. LLC priced a five-year cash-settled equity-linked notes offering for $90.38 million. It was tied to the price of Amazon.com, Inc.

The notes offer principal protection plus an additional return at maturity based on the appreciation of the reference stock above 144% of the strike price.

A trend seen this year

Those two unusually larger deals, especially Deutsche Bank’s $232 million, accounted for more than two-thirds of last week’s volume. This left the rest – $150 million – as the routine mix of contingent coupon and leveraged notes, which is priced on a regular basis each week. Data compiled by Prospect News is revised upward in general as not all deals are filed with the Security and Exchange Commission by press time.

“These big convertible offerings must be reverse inquiries from one or several institutional clients. There’s nothing more to it,” a market participant said.

Except that those large inquiries are repeat deals having an impact on volume.

Since the beginning of the year, more than $1.82 billion in only six issues have been priced in similar five-year cash-settled convertible deals, including one on Tuesday for $600 million brought to market by JPMorgan Chase Financial Co. LLC, which was not counted in last week’s totals. Five of those deals are linked to the share price of insurance company Voya Financial, Inc. except for last week’s Deutsche Bank issue.

“These are definitely not typical structured notes. Why is it being done and who is doing it, I don’t know. But it’s institutional for sure,” a sellsider said, pointing to the minimum purchase size of $100,000.

The reference stocks used in those products – Voya Financial and JPMorgan – are so far financial names.

But this sellsider was not sure how to interpret this in terms of the client’s exposure.

“They may already own the stocks or the sector but it’s weird. It doesn’t appear to be a hedging strategy,” he said.

Year to date up

Volume for the year through April 20 is up 21% to $18.15 billion from $15 billion during the same time last year, according to the data.

The growth is the result of a 25% increase in the number of offerings to 4,776 from 3,834. Obviously, it is also the direct consequence of six mega-deals hitting the market in less than three months. Without this additional notional, volume would only show an increase of 8.8% this year.

There were no such large synthetic convertible deals during that time last year. Bank of Montreal priced a $310.24 million offering on Raymond James Analysts' Best Picks for 2017 in January 2017 but the terms of this product were more in line with a traditional structured note.

Market gyrations

Despite good earnings, the market continued to alternate between advances early in the week followed by losses toward the end. Investors sold technology stocks, especially after Apple saw its share price drop more than 4% on Friday. What triggered anxiety the most was the 10-year Treasury yield flirting with the 3% threshold.

“We can only hope that clients are not looking at daily moves in the market. I don’t. I try not to,” the sellsider said.

“CNBC spends more time speculating than reporting facts. I would advise you never to watch CNBC if you’re an investor. It scares people off. It’s unhelpful,” he said.

A choppy market does not mean there are not many opportunities available to investors in structured products, he added.

“To me the market has hit its top when they passed the tax bill. The market has priced everything in and now it’s behind us. I don’t see anything on the horizon that would fully impact the market.

“What we’re going through right now is a consolidation period that could last several months.”

More autocalls to come

This type of market trend calls for income-oriented products, he noted.

“The stuff we sell right now are index-linked products, worst-of products. I would assume the market will go down but not down that much. With that your notes don’t get called and in the meantime you collect your coupon.”

Last week’s structures were mostly income-based, according to the data. Excluding the $231.75 million delta-one note, volume was $240 million. Autocallable reverse convertibles accounted for $48 million, or 20%, of this adjusted total notional while the size of leveraged notes issuance ($24 million) was half of that.

As seen in previous weeks, the bid on leveraged structures with protection prevails. Last week for instance only $1 million of leverage deals had full downside exposure out of the $24 million in this product type. The rest consisted of either barrier or buffered notes.

Market sentiment may have something to do with the lower interest in return enhanced products.

“As yields increase, the stock market attractiveness lessens,” the market participant said.

“Products or structures with upside leverage built-in will probably be less attractive, not because of the terms but because the outlook for stocks will be subdued,” he said.

The 3% threshold

The yield on the 10-year Treasury only hit the 3% key psychological level Tuesday, not last week. However, it was close by a couple of basis points, unnerving investors who began to worry about an inverted yield curve.

“When you can get a 3% rate on a government bond versus 1.85% in dividends [on the S&P 500 index], it has an impact on the market. This has been the main cause of the sell-off so far,” the market participant said.

“In addition, stocks are richly valued. Therefore, it sort of makes sense to buy products like autocalls that are designed for a range bound market.”

Higher rates will definitely help create more attractive terms, the sellsider said.

“When rates go up, you buy a zero coupon at a cheaper price. That means, you have more left over for the derivatives component,” he said.

“You get more leverage, better protection too because the puts you’re selling can be further out of the money.

“Principal protection especially improves because those products are more sensitive to interest rates.”

Short-term pricing

But the rise of the 10-year bond to 3% will have little impact on the structuring of autocallables.

“Even for a 10-year autocall, the issuer doesn’t fund a 10-year. It funds the expected life, which is something shorter. So it’s the shorter end of the curve that impacts those deals the most.

“The headlines are all about the 10- year. But call features fund in the two- to five-year range, and that part of the curve is already going up,” the sellsider said.

What is more predictable is the shortening of principal-protected notes looking forward.

“What you could only price on a five-year six months ago, you may now be able to do it on a four-and-a-half year.”

The top agent last week was Deutsche Bank due to the pricing by Deutsche Bank Securities Inc. of the $231.75 million deal. Next was JPMorgan with 12 deals totaling $107 million, including its $90.38 million convertible note linked to Amazon.

Deutsche Bank AG, London Branch was the top issuer with one deal, followed by JPMorgan Chase Financial Co. LLC with $115 million in 13 deals.

“What we’re going through right now is a consolidation period that could last several months.” – A sellsider

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