Structured products issuance headed for a flat year; strong bid seen on non-U.S. equity

By Emma Trincal

New York, Dec. 23 – Agents sold $379 million of structured products in the week ended Friday, or 20% less than the week before, and it does not look like volume for the year will be up very much, if it’s up, sources said, based on data compiled by Prospect News. It could be slightly down year over year.

For approximately the first three weeks of the month (up until Dec. 18), agents priced $1.16 billion, a 5% drop from the same period in November. Compared to a year ago, volume fell 5.73%.

Agents priced $42.12 billion this year as of Dec. 18 versus $40.73 billion during the same period last year, a small 3.43% increase.

So far this year the number of offerings is down 8.5% to 8,109 from 8,853 last year, the data showed.

Crystal ball

It remains unknown if December will end up leading the year on a positive, flat or negative trend.

This week and next will be key, sources said. Most deals are expected to price Thursday and Monday.

The closing week of December last year showed a volume of $1.09 billion. For this year, the final weeks of November and October brought respectively $1.45 billion and $1.74 billion to market, according to data compiled by Prospect News.

“I think it’s fair to say that we don’t know if we’ll be up or down. It just looks like we’re going to be flat this year,” a structurer said.

“It’s not bad because issuance has been deteriorating quite rapidly after the summer.

“We had a good run up in the first half, and then we lost all the gains.

“Trying to predict the last two weeks of the year is not realistic. My guess is that we’ll be either up or down by something like 2%.”

Fed move

Last week saw a surge in volatility on the heels of the Federal Reserve’s first rate increase in nearly 10 years. The market immediately rallied on the day, but a pullback followed on Thursday and Friday.

The structurer said rising interest rates was a positive factor for volume.

“It’s a good thing. As an industry we’ve been waiting for this for a long time. Even though the first move last week was very small, it’s still a step in the right direction,” he said.

“It went to a point where investors were getting almost irrational. I’m optimistic for our industry. Income is still a major concern for investors.”

He said the Fed’s move should benefit some structures.

Bid for yield

“I would expect to see more income deals than capital appreciation deals in the upcoming year. Higher interest rates will make those deals easier to put together,” he said.

“The starting point of a structured note is a bond. We’ll have better funding rates, which will make the terms more attractive.

“Meanwhile the yearning for yield is not going away any time soon given that the Fed announcement was still dovish. They said that future hikes will be only gradual.”

Higher rates could also facilitate the reemergence of fully principal-protected structured notes.

“It’s getting there,” he said.

“It’s still difficult to price but we’re moving in the right direction. First we have more deals with guaranteed coupons instead of contingency. Then eventually we’ll see more principal-protected notes.”

Only 73 principal-protected notes were brought to market this year totaling $219 million, or less than 1% of the volume for the year to date.

In comparison, $3.7 billion of such deals priced in 2008 in 421 offerings, or 7.35% of the total.

A market participant said it was unclear whether higher rates would make a difference for the industry.

“There is always a market for structured product. Regardless of where interest rates are, you can customize the structures to meet the specific needs of a particular investor. I don’t really see it as interest-rate dependent,” he said.

“You could say that higher rates on a zero-coupon with upside exposure to an index bring more value because there is more money available in the deal to purchase the options. On the other hand, it really depends on investors’ demand and what their minimum yield targets are.”

Top deal

The top deal last week was a leveraged note as were the top six deals except for one.

Bank of America Corp. priced $74 million of a 14-month Accelerated Return Notes linked to the Euro Stoxx 50 index. The upside and downside participation rates were respectively 300% and 100%. The upside cap was 18.6%.

The second largest deal, also sold by BofA Merrill Lynch, was Barclays Bank plc’s $47.26 million of three-year autocallable market-linked step-up notes tied to the Euro Stoxx 50 index.

The automatic call was triggered at or above the initial price on two annual dates with call premium of 13.1% for the first year and 26.2% for the second. The step-up value was 130%. Investors at maturity received the 30% step-up payment when the index closed below the step level. Above it, they had uncapped long exposure to the index.

Non-U.S. stocks

The third deal was smaller at $21.57 million. It was a leveraged buffered note brought to market by Citigroup Inc. and linked to the MSCI EAFE index.

Investors showed appetite for non-U.S. stocks: the top six deals were linked to international equity indexes.

The structurer offered some explanations.

“First it’s access. Even if you have some international ETFs, there is much more choice in the U.S. for U.S. funds or U.S. equity ETFs,” he said.

“Second, people want to diversify away from U.S. stocks. The two major deals last week were Euro Stoxx, which is the quintessential non-U.S. play. The Euro Stoxx also has a pretty juicy yield.”

This index yields 3.30% compared to 2% for the S&P 500 index.

“Finally people like structured notes on international indices because you don’t have currency risk exposure. That’s due to the quanto feature. An ETF doesn’t give you that benefit. There is no such thing as a quanto option with ETFs.”

The term “quanto” refers to quantity-adjusted option, a derivative providing currency risk hedging.

Unusual worst of

One deal, small in size –it was No. 9 on the list –showed an “interesting” structure, the structurer said after reviewing its terms.

HSBC USA Inc. priced $11.87 million of 5.5% buffered fixed-rate notes due June 19, 2017 linked to the Russell 2000 index and the S&P 500 index. Interest was payable quarterly. The final payment at maturity was linked to the lesser-performing index. The structure offered a geared buffer of 20% with a 1.25 multiple.

“It’s interesting because it gives you a fixed coupon on a short-term maturity with a sizable buffer. Usually you see a barrier with a worst of, not a buffer. You also tend to have an autocall and the coupon is usually not guaranteed,” he said.

“The investor is a little bit more prudent with this product. The interest is not at risk. The buffer gives you more principal-protection.”

The top agent last week was Bank of America with $139 million in only four deals, or 36.52% of the total. It was followed by JPMorgan and Barclays.

“I think it’s fair to say that we don’t know if we’ll be up or down. It just looks like we’re going to be flat this year.” – A structurer, commenting on the year’s final structured products tally

“I would expect to see more income deals than capital appreciation deals in the upcoming year. Higher interest rates will make those deals easier to put together” – A structurer

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