Structured products agents price $233 million in volatile week; year-to-date sales down by a third

By Emma Trincal

New York, May 15 – Structured products issuance volume tallied $233 million in 95 deals for the first full week of the month, slightly below the $300 million average for comparable weekly periods this year, according to data compiled by Prospect News.

The week ended Friday was also the thinnest one in volume for the year to date after the first week of the year, which included New Year’s Day.

Volume figures though are subject to upward revisions as not all deals are counted by press time.

The chunk of the volume was concentrated on one big leveraged deal of more than $50 million.

Bad year so far

The year-to-date decline in volume continued to worsen, showing a 34% drop from $23.1 billion last year to $15.18 billion through May 10. The deal count is down 18% to 4,981 deals from 6,058 deals.

The first four months of this year are the worst since 2006, according to Prospect News data dating back to 2004. The tally for 2004 was $4.80 billion and in 2005 was $8.87 billion based on the same first four-month period.

The fourth “worst year” was in 2006 with $23.24 billion, a much healthier notional size in comparison to this’s year’s flow.

A distributor offered a few explanations from the sellside standpoint, pointing first to the short market cycles seen so far this year.

“Last year you had this volatility spike in February but it was followed by a pretty long stretch of relatively calm markets until the beginning of October. This year is much more erratic...We had a December sell-off, then a rally up until three weeks ago.”

These conditions represent for issuers a pricing and selling challenge all at once.

“When the market changes so quickly you have to readjust the terms of the deal that was already shown a couple of weeks before...what people see at pricing is not going to be what they anticipated.

“A note can really look very different. If volatility drops you may have to reduce the buffer, extend the term, put caps on it or change the buffer from fixed to geared.

“When you hit the low-end of clients’ expectations it has a negative impact on sales,” the distributor said.

Market swings

The rapid market swings also determine clients’ willingness to put money to work, he added.

“From September to December with a market drop of about 20%, almost every manager wanted downside protection. Then comes this rally and we’re reset at all-time highs. Some clients are sorry they were so cautious. They wish they would have been long the market.

“Between the fear of losing money in December and the fear of missing out up until the end of April, private clients feel a little rattled. They’re willing to stay put,” he said.

“It’s frustrating and many of them say – you know what? I’m not going to do anything. We do see clients relatively frozen. They’re not adding notes. They’re not making asset allocation.”

Lower rates

Another factor has been the Federal Reserve shift earlier in January when it put its interest rates hikes on hold, he noted.

Rates whose rise had facilitated the pricing of principal-protected structures last year have declined since the Fed’s switch into neutral gear.

In November, the two-year Treasury was close to 3%. It now yields 2.17%.

“The Fed is not raising rates anymore and it hasn’t helped principal-protected notes and market-linked CDs,” this distributor said.

“It’s not as attractive as what we did last year.

“Clients can now get 2% from cash and if they shop for yield, maybe 2.5%. There isn’t as much of a need to go to fixed [income structured products],” he said.

This distributor was not pessimistic however.

“We’ve only gone through a third of the year. Maybe things will improve in the second half,” he said.

Income explosion

Last week’s structure analysis showed a flurry of income deals.

As a percentage of total volume, autocallable contingent coupon notes hit 51%, which is considerably more than the 31% average for the year. Pure autocall plays (with a call premium paid upon the early redemption) made for 14% of the total notional. Adding both structure categories gives income an unprecedented market share equal to two-thirds of the issuance volume.

As seen before, worst-of deals continued to take center stage with nearly 40% of the total, or $90 million.

Worst-of underliers were evenly split between index or ETFs on the one hand and single-stocks on the other hand.

However, the proportion of single-stocks in the overall notional was 55%, a record for the year compared to a 12% average. One explanation however could be the large size of the top deal of the week, which was leverage on a single name.

The distributor attributed the spike in single-stock worst-of issuance to the rise in volatility seen last week as tariff fears pushed the S&P 500 index 2.2% lower.

“Stocks that have shown recent drops from their highs make for good income notes,” he said.

“Google, Apple have pulled back enough to make volatility levels favorable to the attractive pricing of conditional callable on single names.”

The earnings season also offered opportunities for tactical bets.

“When a company misses its earnings, you don’t need to be in a leveraged note. It may only take three or four quarters to repair. Meanwhile you’re trading in a range. You get paid to wait.”

Supply-side

A portfolio manager said the decline in total sales for the year may have to do with supply.

“I think you need to take a look at what’s being issued. It doesn’t always work with what we’re trying to do for our clients,” he said.

As an example, too many stocks serve as underliers, something most asset allocation shops prefer to stay away from.

“We do autocallables but on indices only, not stocks.

“On a single stock, the company risk is much larger than any market risk.”

Autocallable contingent coupon notes tied to stocks were not his favorite type of structured investment.

“I don’t get it why people would be looking for these freaking coupons out of stocks. And then when stocks are up they regret it. They turn to you and say: why am I not getting the stock return rather than this measly coupon?”

While he would use worst-of deals for broader exposure via indexes or exchange-traded funds, he still believed that clients remained committed to the purchase of plain-vanilla leveraged buffered notes.

“They don’t like that complexity. They like things to be simple.

“I don’t really get it why issuers are pushing those worst-of. You’re taking unlimited downside risk for a small coupon. Especially when they use multiple names...three or four stocks...any one of them can fall on its face.”

Overall, some products miss the mark when it comes to providing the risk-adjusted return profile clients require.

“Our job is to get them maximum return for the minimum risk in their portfolio. 99% of the deals don’t accomplish that goal,” he said.

Big Apple

The top deal last week was a leveraged note on a stock, the exception in a sea of single-stock autocalls.

BofA Merrill Lynch priced on the behalf of Bank of Nova Scotia $55.25 million of 0% 14-month Accelerated Return Notes on Apple Inc.

The size made the offering among the top 20 of the year, in the 17th position. The payout at maturity will be par of $10 plus triple any stock gain, up to a maximum return of 22.11%. Investors will be exposed to any stock decline.

Two autocalls on trios

Back to stocks, Barclays Bank plc priced the second largest deal for $15 million in a two-year issue of step-down trigger autocallables linked to the least performing of the common stocks of Walt Disney Co., Morgan Stanley and Walmart Inc. The notes will be automatically called at par of $10 plus 12.6% per year if each stock closes at or above its initial share price on May 11, 2020 or at or above its downside threshold, 60% of its initial share price at maturity.

Similarly, Morgan Stanley Finance LLC priced another $15 million of worst-of autocalls on three stocks with the same maturity date and barrier level. The call premium is 12.65%.

The underliers are Nike, Inc., salesforce.com, inc. and Costco Wholesale Corp.

The top agent last week was UBS with 58 deals totaling $69 million, or 29.6% of the total. Despite its big trade, Bank of America as an agent was second with $57 million in two deals. JPMorgan was No. 4.

Bank of Nova Scotia was the top issuer, followed by UBS AG, London Branch.

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