Structured products issuance back in post-summer mode with $1.33 billion despite low volatility

By Emma Trincal

New York, Aug. 31 – While the S&P 500 index after hitting new highs mid-August remained in a range with not much movement, investors went back into the structured notes market buying more than $1.33 billion last week, according to data compiled by Prospect News.

The bid was concentrated on Bank of America notes as the agent closed its monthly calendar last week on the final full week of the month.

Bank of America

BofA Merrill Lynch was the top agent with 63.50% of the total, priced in 36 deals totaling $846 million.

“It’s the last week of the month, and they sold a bunch of big deals. They always do that,” a market participant said.

“I guess they had a really good month.”

The overall market was trading sideways last week, ending flat on Friday after comments from Federal Reserve chairman Janet Yellen in Jackson Hole, Wyo., alluding to a potential rate hike in September.

On Aug. 15, the S&P 500 index hit an all-time high at 2,190. Since then, the benchmark has been trading range bound. The second half of August has shown very light volume and low volatility.

August

If August was slow in the equity market, structured notes issuance held up well for this time of the year.

Volume for August through the 26th accounted for $2.28 billion. In the entire month of July, agents sold $3.31 billion. It is too soon to compare the two months as three days have yet to be counted in August after all deals settle.

In addition, the bigger-than-usual volume for July includes not just all of July sales but also Bank of America’s June pricing, or $690 million. That’s because the agent halted its activity at the end of June to avoid the anticipated market turmoil of Brexit, postponing its sales to the early part of July.

August is never the best month of the year. But so far issuance volume improved and jumped up 43% from a year ago. To be sure, August last year saw a severe correction in the global equity markets, which did not help.

Year to date

Volume for the year amounted to $23.66 billion, a 20.81% decline from the previous year’s $29.88 billion.

For the past several months, this year’s notional was showing a 25% decline from the previous year. The gap has now slightly narrowed, according to the data.

“We made up quite a lot. Four percent is encouraging. Still we have to make up for lost ground,” the market participant said.

“Some people say that the market is slow and that investors are afraid to buy at those high levels. It may be true for the stock market, not necessarily for structured products.

“In fact I’m hearing that business is better not just in the structured product space but with other types of instruments. There’s a lot of things going on with 1940 Act stuff.”

He was referring to instruments regulated by the Investment Company Act of 1940, such as mutual funds, unit investment trusts and closed-end funds.

S&P bid

An unusually high volume of deals priced on the S&P 500 index, the data showed.

Forty two offerings totaling $578 million, or more than 43% of the market, were linked to the U.S. benchmark.

The top six deals were all based on this underlying, making for nearly a third of the total.

“It’s a lot, but it doesn’t surprise me at all,” said the market participant.

The fear of Brexit may have dissuaded some investors from buying into the Euro Stoxx 50 index, he said.

But the main reason remained the search for yield.

“I have my theory about this. People are not just seeking yield. They have to get yield,” he said.

The five-year swap rate has been “hovering around” 1.2% for the past three months, he noted.

Meanwhile, the three-month Libor has “jumped” to 83 basis points from 40 bps in December.

“Libor doubled. A lot of financing is tied to Libor.

“That means the return on your investment remains stubbornly low while the cost of your liabilities goes up.

“You need money to work for you.”

He explained that the emphasis on structuring deals tied to S&P 500 index was the result of a growing need to generate income.

“Whether you like the market or want to be in it but worry to go in at the top, structured products can monetize this index to give you the protection, the leverage or the high probability of a high-yield.

“Having a structured product referencing the S&P makes the most sense.”

No better place

Investors may also be flocking around the S&P 500 index for lack of a better place to invest in, said an industry source.

“The S&P is the only bright spot around the world right now,” this source said.

“There is divergence. The rest of the world is talking about more accomodative policies while the U.S. is talking about raising rates.

“There’s a more bullish stance in the U.S.”

Another factor was Bank of America’s calendar: the leading agent often prices a majority of plain-vanilla notes with the most widely recognized benchmark, he said.

Leverage

Leverage with or without downside protection regained momentum last week with $750 million making for 56% of the total. Half of this volume was found in the top 10 list of deals.

“Leverage even with 100% of your money at risk is a form of protection in a way,” the market participant said.

“You put less capital at risk and your downside isn’t leveraged. This is not easily replicable with an ETF.”

Top deals

The top 13 deals, or nearly half of the total volume, were all distributed by BofA Merrill Lynch.

HSBC USA Inc. issued the top deal with $134.79 million of 14-month leveraged notes linked to the S&P 500 index. Investors at maturity received par plus three times the index gain up to an 11.76% cap and were fully exposed to the downside.

“It doesn’t have any protection. But any kind of protection doesn’t price that well. I’m not surprised it was the most popular deal,” the industry source said.

“It’s a decent deal because you get 10% annually. The market is toppish... it might go sideways. To have three times is good positioning. I’m not sure it’s the best positioning without a protection. But with a protection your cap would be ridiculously low.”

Bank of America Corp. issued the second largest offering with $72.91 million of two-year capped Leveraged Index Return Notes linked to the S&P 500 index. The leverage factor was two, the cap, 13.6% and the structure offered a 10% buffer on the downside.

The third deal also brought to market by HSBC and tied to the S&P 500 index was a five-year leveraged buffered product with 1.24 times leverage on the upside and no cap. There was a 20% buffer on the downside.

The No. 4 offering was brought to market by Credit Suisse AG, London Branch with $56.52 million of 14-month notes linked to the S&P 500 index with two times leverage, an 8.92% cap and a 5% buffer.

Step-ups

The two following deals – fifth and sixth in size – were both issued by HSBC USA Inc. for $42.13 and $36.13 million, respectively. Both were autocallable market-linked step-up notes tied to the S&P.

The first one, a six-year note, had a 140% step-up value on the upside and an 85% barrier on the downside.

The second one, a three-year product, showed a 125% step-up value and no downside protection.

Both deals were called automatically on an annual observation basis when the index was at or above its initial price. The call premium was 6.4% a year on the first deal and 8.65% on the second.

After BofA Merrill Lynch, the second biggest agent was JPMorgan with $136 million in 50 deals, or 10.25% of the issuance. Goldman Sachs was third with 5% of the market in nine offerings totaling $66 million.

“Some people say that the market is slow and that investors are afraid to buy at those high levels. It may be true for the stock market, not necessarily for structured products.” – A market participant

“The S&P is the only bright spot around the world right now.” – A market source

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