Structured products issuance volume slow on week, flat for year; sources question rally’s input

By Emma Trincal

New York, Feb. 22 – Structured products issuance volume was thin ahead of the Presidents Day holiday weekend, and the yearly trend was flat. This had some sources wondering why volume is not much stronger this year given the strong bull market that has unfolded since the election of president Donald Trump in November.

The S&P 500, Nasdaq and Russell 2000 indexes rose to record highs again last week, posting gains for the fourth consecutive week. The S&P 500 index was up 1.5% for the week. It has gained 13% since the elections.

Meanwhile agents sold $249 million in 129 deals in the week ended Friday, according to preliminary data compiled by Prospect News.

Sales amount to $5.68 billion in 1,454 deals for the year through Feb. 17 versus $5.45 billion during the same time last year, a 4.2% increase.

Year-to-date volume

“A 4% rise is too small to read much into it. It could be noise. I wouldn’t say volume is up just yet. To me 4% up is flat at this stage,” a structurer said.

“Generally speaking the sentiment from the rally is good. But nobody expected it. Most people believe it’s unsustainable.”

Whether investors question the strength of the rally does not change the fact that market conditions a year ago were just the opposite. On Feb. 11, 2016, the S&P 500 bottomed for the year and the market was going through a correction in the first six weeks of the year.

A sellsider explained that strong rallies may leave investors ambivalent about buying structured notes.

“Sometimes when the market is up quickly as it has been, people can be staying on the sidelines,” he said.

“They want to see how the Trump [presidency] plays out.”

He was referring to investors’ optimistic expectations regarding president Trump’s promises to cut tax rates and to reduce regulations, especially in the financial sector.

“They’re not super convinced that this is a real rally,” he said.

This sellsider had a different take of the year-to-date volume growth.

“I think being flat is good. The [issuance] volume trend has been dropping in the past couple of years. So if we’re up 4%, it’s encouraging,” he said.

“Things are starting to price a little bit better as rates are going up a little bit. Volatility is picking up a little as well.”

DOL, credit spreads

Some factors may contribute to reduce issuance however, he said.

“On the regulatory front, we’re still trying to figure out what’s going to happen with DOL,” he said.

He was referring to the Department of Labor’s fiduciary rule, which is set to take effect in April. Its implementation status remains murky as it may be amended, repealed or postponed by the new administration.

“In addition, a couple of issuers, in particular Deutsche Bank, are under pressure. Their credit is getting beaten up a little bit.”

Deutsche Bank’s five year credit default swaps are at 149 basis points, according to Markit.

In comparison, most large U.S. banks have spreads that range between 45 and 85 bps, the financial service information provider showed.

But this sellsider remains optimistic for the U.S. structured products space.

“In general, our market has been hanging in there pretty well,” he said. “Assuming no major blow-up, we should see volume picking up when rates go up a little bit more.”

Trump risk

The structurer was more cautious.

For one thing, rates have increased but not enough, and volatility remains too low, he said.

But more importantly the rally is based on fragile political assumptions, raising the issue of political risk.

“Investors continue to be bullish based on their expectations for less regulation and tax cuts,” he said.

“But all those pro-growth policies have been priced in in advance. What if it doesn’t pass or gets delayed?

“Right now you have probably some performance-chasing. The month has been phenomenal. When the market goes up, people jump in. They don’t want to be left out. But that could also be working in reverse quite quickly.

“Honestly it’s hard to argue why this would continue for a long period of time.”

Some investors may wait for a downturn before adding more money in the market.

Others following the “performance-chasing” trend may prefer to get full exposure to equity.

Both factors may be at work to lower demand for structured notes at the moment, he said.

Structures

Equity-linked notes made for 93.75% of total volume last week, a high market share even by bullish standards, according to the data. Last year’s average was 87%.

Leveraged notes products accounted for 30% of the total.

Leveraged notes are likely to remain the most popular type of structure, the structurer said.

“One thing that has been working from an industry perspective and performing well is leverage,” he said.

“Leveraged products will do well in this market cycle.

“And since structured notes are sold rather than bought, people selling them can make a pretty good case with leverage that it’s been doing well.”

Last week however was rich in income products. Those made for 31% of the total.

Each of the top three deals showed an income or fixed payout component.

Top deals

JPMorgan Chase Financial Co. LLC’s $34.27 million of three-year autocallable buffered equity notes linked to the S&P Banks Select Industry index, was the largest offering to price last week.

If the index closed at or above its initial level on either of two call observation dates, the notes would be automatically called at par plus a call premium. The call premium was 9.9667% on year one and 18.4% on year two.

At maturity, the payout was 27.6% if the index was flat or positive. There was a 10% geared buffer on the downside at a rate of 1.11. The notes were guaranteed by JPMorgan Chase & Co.

“This is a decent product but a risky one,” the structurer said.

“There’s a high volatility in the underlying sector because it’s highly concentrated. People have high earnings expectations on banks based on the hopes for less regulation.”

But if the “policies don’t come to pass,” he said, the S&P Banks Select Industry index, which has been the best sector since the elections, could “give up recent gains,” he warned.

Morgan Stanley Finance LLC priced the No. 2 deal with $20.78 million of six-year trigger jump securities linked to the Euro Stoxx 50 index.

This structure allowed participation in the upside but offered a digital payout as a minimum return.

If the index return was positive, the payout at maturity would be par plus the greater of the index return and 80%. Investors would receive par if the index fell by up to 40% and would lose 1% for each 1% decline from the initial level if the index declined by more than 40%.

The notes are guaranteed by Morgan Stanley.

“It’s a long-term view on the Euro Stoxx. I like the idea, but it’s extremely expensive given the long maturity and the loss of dividend, especially for this index. You’re also taking the risk on Morgan Stanley’s debt.”

The Euro Stoxx 50 index yields 3.3% versus 2% for the S&P 500 index.

Barclays Bank plc priced $15 million of three-year review notes linked to the least-performing of the Russell 2000 index, S&P 500 index and Euro Stoxx 50 index. It was the third offering in size, according to preliminary data.

The notes were automatically called on two annual review dates if the worst-performing index was at or above its initial date or if it was above a 75% barrier at maturity. The premium was 12.81% a year.

Barclays was the underwriter with JPMorgan acting as placement agent.

The top agent last week was JPMorgan with 17 deals totaling $71 million, or 28.55% of the volume. It was followed by Morgan Stanley and Goldman Sachs.

JPM Chase Financial Co. was the top issuer.

“Generally speaking the sentiment from the rally is good. But nobody expected it. Most people believe it’s unsustainable.” – A structurer

“Things are starting to price a little bit better as rates are going up a little bit. Volatility is picking up a little as well.” – A sellsider

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