Structured products agents price $378 million in week; worst-of deals take precedence

By Emma Trincal

New York, April 24 – Structured products issuance was reasonably strong in a short holiday week ahead of the Easter weekend with $378 million priced last week in 172 deals, according to preliminary data compiled by Prospect News. The market was closed on Friday for Good Friday.

Worst-of structures prevailed over leverage, reaching a notable 60% share of the total.

The month showed a slight increase in volume for the first time in weeks. Sales amounted to $1.03 billion through April 19, a 3.3% increase from $997 million in the previous comparable period.

Unfortunately, this volume compared to a year ago showed a 47.4% drop from $1.96 billion.

The S&P 500 index fell slightly by 0.1% in a truncated, holiday week in this second week of the earnings season.

Volume down

While the market is near record-highs, the growth of issuance volume for the year to date is negative. Sales dropped 38.3% this year through April 19 to $11.83 billion from $19.16 billion.

One display of this trend is the significant drop in block trades during the period: the number of deals in excess of $50 million is 13 this year, which is nearly half of last year’s count of 28.

The number of deals overall is also concerning: 3,966 so far from 5,048 last year, a 21.4% decline.

“These numbers are not encouraging. It’s certainly market-related,” a sellsider said.

For the total trailing 12 months, sales are down 11.3% to $49.5 billion. Volume for the previous period from April 20, 2017 to April 19, 2018 was $55.82 billion.

A rally with doubts

“The market is toppy. It’s back to its all-time highs and it’s hard to form a view,” the sellsider added.

“With the S&P so high, betting against the market is scary. But being bullish is not so easy either because there’s a lot of uncertainty.

“To me this should not be bad news for the industry. The more uncertain the market is, the more people should be looking at structured notes.”

He pointed to the benefit of customizing notes with a defined outcome, which may be better adjusted to an investor’s view than a long position in stocks.

“A barrier can help.

“If the market goes down, you still achieve your purposes.”

He advised patience.

“I’m not really concerned about the future. Volume will come back,” he said.

Leverage retreating

Last week’s structures presented similar characteristics as in prior weeks but with more magnitude.

For instance, worst-of products have regained momentum over the past couple of months. Last week, $223 million of worst-of deals hit the market. What was unusual was the high proportion of those products in the totals.

In a similar way, leverage, which prevailed up until last month, was disregarded last week.

Leverage represented only 12.5% of total sales last week versus 63.1% for autocallable with contingent coupon deals.

This small share contrasted with the year-to-date average of 40% for leverage and 30% for autocallable, according to the data.

Broader bets

In weeks when income-oriented products prevail, the use of single-stocks tend to increase. Note last week when stocks represented 21% of the total volume versus 63% for indexes. Exchange-traded funds made for 6.5% of the sales.

It’s as if most investors turned to worst-of via indexes or exchange-traded funds for their core allocations, seeking diversification away from stocks and taking bets on the broader market or alternatively on a sector versus another.

This trend did not surprise the sellsider.

“The market is rich right now. People want to express a short-term view. They don’t want more than one year of risk. That’s why autocalls are in favor. You could be holding the note for only three months.,” he said.

Investors also want to slice the market in sector plays, he noted.

“It doesn’t make sense to do a leverage bet on a sector.

“Worst-of allow you to express views on a sector versus another. It’s a short-term view. It’s a tactical play. And it’s a way to generate cash-flow,” he said.

Fewer stocks

Income-oriented products tend to be well adapted to markets when conviction is lacking, said a market participant.

“Most of our trades have expressed a range bound view. You get to put a cap on a note and the tradeoff is some kind of downside protection. People like it especially if they don’t expect the market to go up a lot more,” this market participant said.

Triplets

Another characteristic was the use of three rather than two underliers in those worst-of deals, which did not seem to pose a problem to some investors. In some other instances, indexes and ETFs were combined in a mix of two or three reference assets.

Examples of those underlying “baskets” include the combination of the iShares MSCI Emerging Markets ETF with the Dow Jones industrial average. This Emerging Markets ETF was also used in pairs with either the Russell 2000 or the Euro Stoxx 50 index. Notable sector pairs included the SPDR S&P Biotech ETF and SPDR S&P Oil & Gas Exploration & Production ETF for instance as well as the mix of SPDR S&P Biotech ETF and Technology Select Sector SPDR fund.

Sector bets

For the sellsider the appeal of worst-of ETFs or their inclusion in worst-of deals tied to indexes was easy to explain.

“It’s very natural that people would want to express sector views in worst-of. ETFs are designed for that. You can achieve interplays with sectors. That’s how ETFs come handy,” the sellsider said.

“Also, a lot of sectors don’t have a designated index. And even if they do, you may not have futures on these indices. The ETFs gives you more opportunities to price structured products. Banks need to hedge, and if you don’t have futures to trade on the index, you need an ETF.”

Nasdaq king

Another “underlying asset” trend albeit a less recent one has been the growing emergence of the Nasdaq-100 as a top underlier mostly for worst-of deals. The Euro Stoxx 50 index, which traditionally was the companion of choice of the S&P 500 index for those products, seemed to have been replaced by the tech benchmark in a rise of U.S.-centric trades.

For instance, $31.8 million of notes were linked to the Euro Stoxx 50 index last week (mostly in worst-of) while the notional amount for the Nasdaq was $50 million.

“I think this is about making more targeted bets,” the sellsider said.

“The Nasdaq-100 gives you exposure to large companies outside of the financial sector. You get exposure mostly to tech stocks and biotech. It’s a more tech-heavy bet, with less components and it’s also a domestic index.”

Asked whether this renewed interest in the Nasdaq 100 has been taking place at the detriment of the Euro Stoxx 50 index, he said that it was a possibility.

“You now have political risk in Europe. People may not be too comfortable with the asset class. Or they may have overallocated to the region and need to rebalance their portfolio toward the U.S. market,” he said.

Another factor may simply be growth. Technology is a magnet for bulls. Last week, the Nasdaq-100 hit an all-time high.

Another possible reason: the Nasdaq allows for an enlarged exposure to the so-called FANG stocks, which have remained popular. Investors are on the lookout for the “next big thing,” an industry source said.

“We’re seeing millions of dollars going into technology,” he said.

Tactical trades

The increased use of the Nasdaq-100 and ETFs in worst-of deals could derive from the same cause.

“There are only so many things you can play with when you invest in several underliers,” the sellsider said.

“You can do large-caps versus small-caps, Europe versus the U.S., in some cases stocks against stocks.

“If you want to be more tactical, you go for sectors. Both the Nasdaq and most ETFs can do that.”

Investors were seen making short-term tactical bets on health care as the sector was under pressure last week due to fears of legislative reforms in Washington that would introduce Medicare-for-all.

Issuers priced small deals on CVS Health Corp., Regeneron Pharmaceuticals, Inc., Bristol-Myers Squibb Co. and Merck & Co., Inc., according to the data.

Some worst-of deals in the beaten-up sector included CVS Health and Walgreens Boots Alliance, Inc. Alternatively a couple of small worst-of deals were linked to the SPDR S&P Biotech ETF and Technology Select Sector SPDR fund.

Earnings bets

Earnings also called for tactical plays, this time mostly based on single-stocks.

“Banks look at earnings the way they would look at anything else. They want to show ideas that have some appeal,” the sellsider said.

“They’re going to price based on volatility. But they don’t really care about volatility, or they don’t care about it the way investors do. For banks, everything they trade is hedged. They’re agnostic.

“For investors, it’s an entirely different ballgame. They look at earnings as opportunities. The person that takes the view and ultimately the risk is always going to be the investor,” the sellsider said.

The largest “earnings-related deal” was tied to Schlumberger NV. It priced on Thursday, the day the company reported its earnings. UBS AG, London Branch was the issuer.

Other underlying stocks in separate deals included Facebook, Inc., Amazon.com, Inc. and AT&T Inc. all set to report on the following week.

Top deals

Barclays Bank plc last week issued the top two deals. Both were distributed by UBS.

The first one was $11.28 million of 10-year autocallable contingent coupon notes linked to the lesser performing of the Nasdaq-100 index and the Dow Jones industrial average.

Each quarter, the notes pay a contingent coupon at an annual rate of 6.65% if each index closes at or above its coupon barrier, 50% of its initial level, on the observation date for that quarter.

Beginning April 16, 2020, the notes will be automatically called at par of $10 if each index closes at or above its initial level on any quarterly observation date. There is a one-year no-call.

The principal repayment barrier at maturity is 50%.

The second deal priced for $10.72 million. It was linked to the Nasdaq-100, the Russell 2000 and the S&P 500 indexes. The contingent coupon is 10%, the coupon barrier, 70%. Calls and payments are set quarterly with the automatic call kicking out at the first quarterly observation date. The barrier at maturity is 60%.

Closely behind, GS Finance Corp. priced another worst-of deal tied to the Euro Stoxx 50 index, the Russell 2000 index and the S&P 500 index.

The No. 1 issuer for the second week in a row was Barclays Bank with $74 million in 21 offerings, a 19.6% share.

Barclays year to date climbed as the top issuer with $1.669 billion in 461 deals. But JPMorgan is tightly behind with $1.648 billion issued.

“With the S&P so high, betting against the market is scary. But being bullish is not so easy either because there’s a lot of uncertainty.” – A sellsider

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