Structured products issuance high amid stock market sell-off; new $350 million deal third largest

By Emma Trincal

New York, Feb. 7 – While the stock markets tumbled last week, investors continued to buy structured notes at a robust pace. Size mattered too as the top deal of the year priced for $350 million. Brought to market by JPMorgan and linked to a single-stock, it was the largest deal to price in the U.S. since February 2016, according to data compiled by Prospect News.

Solid volume

Agents sold $1.10 billion of structured products in 151 deals in the week ended Friday, which overlapped with February, according to the data. The chunk of January pricing – or the official closing of the month – occurred during the previous week, which saw a total notional of $2.37 billion with BofA Merrill alone contributing to $1.1 billion of it, according to updated data compiled by Prospect News.

Last week in contrast was dominated by two other big agents – JPMorgan and UBS as BofA Merrill Lynch was nearly absent from the market, according to preliminary data.

Bad week for stocks

The stock market had its worst week in two years with the Dow Jones industrial average finishing down for the week more than 4%. The sell-off extended and worsened on Monday as the benchmark dropped more than 1,000 points.

Volatility rose last week, spiking this last Monday and setting a one-day record move. Apparently, the sudden change in the market did not hurt issuance volume. If anything, it must have boosted demand for structured notes, said Matt Rosenberg, sales trader at Halo Investing.

Vol is back

The question on every investor’s mind, structured note buyer or not, is whether the recent sell-off marks the end of the long bull market.

“We’ve been waiting for some level of volatility to come back. Now we have some,” said Rosenberg.

“It prompted my end-clients to call their advisers. It’s been a common theme. You’ve had this fabulous run in the market over the past 15 years. You’ve got those gains. You see a blip in volatility. What do you do next?”

Investors choose either growth products or income notes in an attempt to either get some downside protection or lock in higher yield on shorter durations, he explained.

Income still wanted

“We continue to see a lot of demand for income. But people are interested in doing both income and leverage with downside protection,” he said.

Rosenberg said that the average investor is not buying bonds because of interest rate risk and duration risk.

“People made a lot of money with income notes. You can be called. You have shorter durations than bonds. And now that volatility has been up a few days, you’re getting much better terms,” he said.

Even if a persistent sell-off leads autocallable note holders to skip the calls and have longer durations than anticipated, the terms offered by income notes have improved.

“You’re getting more and more fixed coupons. Coupons are higher and barriers lower. The volatility spike is helping pricing,” he said.

He gave an example. A worst-of on the S&P 500 index and the Russell 2000 giving a few days ago a 7.5% yield can now be priced at 9.5%.

Mere correction

With no visible signs of recession – one of the triggers pushing down the markets on Friday was a strong jobs report – many believe the stock market pullback is a mere correction. The cause of the sell-off is inflation concerns. Last week saw the 10-year Treasury yield breaking above 2.85%, its highest level in four years, causing volatility to rise.

“While we might see a minor correction, right now demand for structured notes is rising. People tend to move into cash when volatility rises. Instead of sitting on cash, they can reallocate 5% of their portfolio in a growth note with a buffer attached to it as a replacement for an ETF exposure,” he said.

“They can also use the volatility to get attractively priced income products.”

Structures, year

Leveraged notes prevailed in volume last week with $321 million in 28 deals, or 30% of the total, according to the data. Two-thirds of those return enhanced products came with a buffer or a barrier; the rest had no downside protection.

Autocallable reverse convertibles amounted to nearly $200 million, or 18% of the total in 91 deals.

Equity-linked notes tied to indexes accounted for 57% of the total volume while stocks represented a third of it.

On a yearly basis, volume for the trailing 12-months to Feb. 2 is up nearly a third to $51 billion from $38.5 billion for the previous rolling period, the data showed.

“It seems like a strong start for the year with advisers and portfolio managers rebalancing their portfolios and looking to get ready for any headwinds. I really believe that 2018 is going to be an even better year than last year,” Rosenberg said.

Let’s see what happens

A sellsider was more cautious.

“This was last week. But since that we’ve had Monday. The market continues to have big moves. It’s too soon to tell how volatility will impact demand for structured products,” he said.

“We’ll have a better idea this week. Retail doesn’t move that fast.

“The idea that when the market is crashing, people get up and say ‘let’s buy some stuff’ is a bit of a stretch. People do worry.

“I’m not saying we’ll have a crash. But it’s not as simple.

“The next few weeks will tell us whether people are going to reallocate to risk or to less risky products.”

Third biggest deal

Deals last week were large in size. Delta one products prevailed.

JPMorgan Chase Financial Co. LLC priced $350 million of five-year cash-settled convertible notes linked to Voya Financial, Inc. stock with a coupon of 0.25% and an initial conversion premium of 32.5%.

It was the third largest deal to price in the United States since June 2005 when Prospect News began collecting data on equity indexes.

Record deals

The prior largest deal came in two years ago. It was Goldman Sachs Group, Inc.’s $1.07 billion of one-year leveraged notes linked to a basket of international equity indexes, according to Prospect News data.

The basket consisted of the Euro Stoxx 50 index with a 58% weight, the FTSE 100 index with a 19% weight and the Topix index with a 23% weight.

The record and biggest trade before that was UBS AG’s $2 billion 22% mandatory exchangeable notes due Aug. 15, 2007 linked to Time Warner Inc. This deal, which priced in February 2006, was privately placed.

Last week’s $350 million convertible deal paid at maturity an amount in cash equal to the sum of the daily value on each of the 20 valuation dates, which are the trading days ending two trading days before maturity.

“This is a little bit different, but I like the concept of averaging out,” said Rosenberg.

“Structured notes only reference one day. Imagine a note maturing this past Monday when the market plunged. Then it pops the next day. Averaging is a way to get the truer return. It can be especially useful for a larger allocation.”

Other big trades

Citigroup Global Markets Holdings Inc. priced the second deal for $52.8 million. It consists of 19-month leveraged buffered notes tied to the S&P 500 index. The upside leverage factor is 1.4 up to a cap of 18.23%. A 10% geared buffer with a 1.11 multiple offers some downside protection.

“This chunky deal shows there’s still demand for growth. This one is an opportunity for investors who are cautiously optimistic, people who are still bullish on the market,” said Rosenberg.

Next GS Finance Corp. brought a large commodity block trade of $45 million. The 13-month notes provide one-to-one exposure to the Bloomberg Commodity index.

“With concerns over inflation, more people are naturally looking for commodity exposure. I’m not sure the delta one exposure is very attractive though. In general, I haven’t seen very attractive pricing on commodities. Maybe it’s the options on it. A lot of it is limited to futures,” said Rosenberg.

JPMorgan tops

The top agent last week was JPMorgan with $420 million in 15 deals, or 38% of total volume. It was followed by UBS and Goldman Sachs.

JPMorgan Chase Financial Co. LLC was the No. 1 issuer with $396 million in 12 deals.

JPMorgan, the agent, priced three deals on the behalf of Deutsche Bank AG, London Branch for about $25 million.

JPMorgan Chase Financial Co. LLC issued the 12 others.

“We’ve been waiting for some level of volatility to come back. Now we have some.” – Matt Rosenberg, sales trader at Halo Investing

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