Structured products volume weakens in month-end week ahead of Labor Day as S&P 500 hits record

By Emma Trincal

New York, Sept. 3 – The week ended on Friday with the S&P 500 index hitting a new high at 2,003.37, but structured notes issuance dragged on with $877 million sold in 251 deals, according to data compiled by Prospect News.

It was the final week of the month. But in size, last week’s volume represented the smallest month-end week of the year so far in dollar amount, according to the data.

The top month-ending weeks were in January ($2.01 billion) and May ($1.90 billion).

The decline was visible on a month-to-month basis as well. Agents had sold $2.85 billion last month as of Aug. 29, a 20.35% decline from the same period in July.

Because of the Labor Day weekend falling at the end of the month, the month-to-month drop is even greater when taking into account the volume for the entire month. August sales through the 31st remain the same at $2.85 billion, but compared to July’s $3.88 billion, the decline increases to 36%.

Lackluster August

“August was a disaster,” a sellsider said.

“I’m expecting a number of layoffs in several firms in the fall. It’s a little bit the same stuff each year after a slow summer, but August this year was one of the worst.”

This year’s August is indeed the worst in three years. Since 2009, the best months of August were in 2011 ($3.53 billion), 2013 ($3.37 billion) and 2012 ($2.87 billion), according to the data.

“Everybody is fixated on equities,” the sellsider added.

“Interest rates are not moving. People thought rates would go up next year. It turns out the Fed is likely to keep them low for a long time; people talk about a hike in 2017. This is not good for our market. It makes deals impossible to price.”

The silver lining is the year-to-date volume, which has increased by 10.42% to $28.05 billion from $25.40 billion priced last year as of Aug. 29.

However, when taking into account the full month of August (Jan. 1 through Aug. 31 versus the same period of last year), the increase lessens to 9.50%.

“Look, volume is up year to date by almost 10%. We’re losing ground a little bit. I think we were up 13% in July for the year,” a structurer said.

“I don’t think it’s a big deal though. We’d like to keep the same pace, but August was a bit slow, and last week people were on vacation with the Labor Day weekend.

“The holiday fell at the end of the month, which can really kill numbers.

“The equity market is at all-time highs, which has a mixed impact on volume. People have reasons to be both encouraged and skeptical.

“The important thing is that we’re still up for the year. We’re not out of the woods yet, but hopefully, we’ll finish the year up.”

‘War machine’

BofA Merrill Lynch’s presence last week was noticeably high. The leading firm priced 37% of the total volume in only 12 deals totaling $323 million. On average for the year, BofA Merrill Lynch accounts for 27% of the market, but its impact is felt the most at the end of each month when it closes its deals.

BofA Merrill Lynch priced the top six offerings last week in a size range of $24 million to $50 million, according to the data.

“BofA Merrill Lynch is a war machine,” the sellsider said.

“Having just one bank pricing a third of the U.S. market is not exactly healthy. It goes to show the huge market segmentation that we have with on the one hand the big ones – the Merrill Lynch, the JPMorgan and the UBS – and on the other hand everyone else, all the little guys.”

The top deals brought to market by BofA Merrill Lynch were a combination of step-up notes and leveraged plays.

The No. 1 offering was linked to a single stock and geared toward income-seekers.

Step-ups

Bank of America Corp. priced $50 million of 9.5% STEP Income Securities due Sept. 14, 2015 linked to the American Depositary Receipts of Petroleo Brasileiro SA. Interest is payable quarterly.

If the price of Petrobras ADRs finishes at or above the step level, 109.5% of the initial price, the payout at maturity will be par of $10 plus 1.75%.

If the stock finishes below the step level but at or above the threshold value, 95% of the initial price, the payout will be par.

Investors are exposed to any losses beyond the 95% threshold value.

The market-linked version of a step-up was offered in the No. 2 deal, Bank of America’s $44.71 million of autocallable market-linked step-up notes due Aug. 26, 2016 linked to the S&P Oil & Gas Exploration and Production Select Industry index.

The notes will be called at par plus a call premium of 10% if the index closes at or above its initial level on Aug. 31, 2015.

If the notes are not called and the index finishes above the step-up value, 128% of the initial level, the payout at maturity will be par plus the index gain.

If the index finishes at or below the step-up level but at or above the initial level, the payout will be par plus the step-up return of 28%.

Investors are exposed to any losses.

Sector bets

This theme-oriented deal illustrates a trend seen last week among BofA Merrill Lynch’s best-selling deals: the appeal of sector- or country-specific plays.

“People are going into sectors, going down the risk spectrum,” a market participant said.

“They’re looking for more volatility. The S&P 500 hit the 2,000 threshold last week and has been a little bit depressed since then. It’s driving the move toward sector plays, country plays, toward riskier assets in general.

“People have to find places to monetize higher volatility, so they’re going into sectors and single stocks.”

The interest in single-stock underliers is one of the most established trends of the year, the data showed. Single-stock deals amount to $7.89 billion this year to date, a 42% increase from last year’s $5.57 billion. The market share for these products is 28% this year versus 22% last year.

“The S&P keeps on breaking new ground. Even though many in the market believe there is a lot of upside left, you’re seeing investors getting increasingly cautious,” the structurer said.

“If investors want to invest in stocks, they have the choice: they can be long the stocks or they can use structured notes with a barrier or a buffer. Since people are worried about a correction, using structured notes is the prudent way to go. It’s a way to play stocks with more protection than being long-only.”

In the fourth and fifth largest deals, BofA Merrill Lynch continued to offer more sector plays to investors.

The No. 4 deal was a housing bet, Bank of America’s $38.91 million of autocallable market-linked step-up notes due Aug. 26, 2016 linked to the PHLX Housing Sector index. The annual call premium is 10% with a threshold set at the initial index level.

If the index finishes between the initial level and the 126.25% step-up level, the payout will be par plus the step-up return of 26.25%.

Above the step-up level, investors receive par plus the index gain. There is no downside protection.

“Seeing more and more sector plays is a natural and healthy evolution for the market,” the structurer said.

“In the old days, structured products were mostly on single stocks, with the common use of reverse convertibles. You also had stock baskets. Then investors moved into the major market benchmarks.

“Sector plays are a more recent stage of development. It has a lot to do with people looking at structured products not just for the payoff but in terms of picking the underlying of their choice.

“You see a lot more people applying ETFs in a structured note instead of just buying the ETF. They will use sector ETFs or country ETFs to express a particular view on a specific theme.

“It’s a different way to invest in ETFs. People are embracing ETFs not just as a direct investment but as a way to create a different risk-reward profile, which is what’s unique about structured products.”

In the No. 5 deal, BofA Merrill Lynch brought to market another sector bet on oil stocks. Bank of America priced $34.5 million of 0% Accelerated Return Notes due Oct. 30, 2015 linked to the S&P Oil & Gas Exploration and Production Select Industry index. The structure is a leveraged note with no downside protection offering three-times leverage on the upside up to a 16.95% cap.

“Those sector-specific deals are more interesting than the S&P 500,” the sellsider said.

“It’s a way for people to diversify and look for alpha in the best-performing sectors. Some sectors really outperform while others underperform, so picking the right one is a smart strategy.

“This one is another oil deal, and we see a lot of these. I’m not a fan of oil. Oil is not going anywhere. You really need a massive crisis for oil to rally, and despite everything that’s going on in the world right now, I guess we’re not there yet.”

Canada

More unusual was the use of a Canadian equity index seen in a barrier leveraged note, the seventh largest offering in size. UBS was the agent.

The deal was HSBC USA Inc.’s $21.76 million of 0% trigger performance securities due Aug. 30, 2019 linked to the S&P/TSX 60 index. The uncapped upside is leveraged at a rate of 168%. The downside is protected by a 75% final barrier.

“We see deals tied to Canadian stocks very infrequently. Canada is not part of the MSCI EAFE. It’s not immediately on investors’ minds,” the market participant said.

The No. 2 agent last week was UBS with 97 deals totaling $176 million, or 20.05% of the total.

It was followed by Goldman Sachs with $81 million sold in 17 offerings, or 9.18% of the volume.

“August was a disaster.” – A sellsider

“People have to find places to monetize higher volatility, so they’re going into sectors and single stocks.” – A structurer

© 2015 Prospect News.
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