Structured products tally for week $408 million; heavy bid on fixed-to-floaters eyed

By Emma Trincal

New York, March 1 – Structured products agents priced $408 million in 64 deals in a holiday-shortened week ended Feb. 24 marked by renewed fears of inflation and rising yields, leading to the worst week of the year for the stock market.

Another large fixed-to-floating rate notes deal stood out. It was brought to market by Goldman Sachs Group, Inc. for $150 million following another large one – Toronto-Dominion Bank’s $250 million, which priced the week before.

The appeal of those typically short-term deals on swap rates is in line with the sharp rise in interest rates on the shorter end of the curve, a source said.

Last week, higher-than-expected inflation figures rattled the stock market pushing the Dow Jones industrial average 3% lower. Meanwhile Treasury yields continued to rise on inflation concerns especially on the short-end, inverting the yield curve further to spreads not seen in decades.

The higher yields on short-term notes may not necessarily be reflected in the pricing of shorter tenors.

For instance, the average tenor this year is only slightly shorter than a year ago (2⅓ year versus 2¾ year, respectively). But the terms and pricing conditions have improved almost across the board.

High rates, hot products

Goldman Sachs Group priced its $150 million of fixed-to-floating rate notes due March 27, 2024 on Thursday.

The coupon payable monthly will be 6% per annum for the first six months switching thereafter to the one-year U.S. Dollar SOFR ICE swap rate plus 20 basis points, subject to a floor of 0.1%.

The payout at maturity will be par.

Goldman Sachs & Co. LLC and InspereX LLC are the underwriters.

“Rates are moving. It’s now in vogue,” said a market participant about the size and frequency of large sized fixed-to-floating rate note issues.

“People don’t necessarily need or want cross-asset exposure if they can achieve it with bonds. These notes are lightly structured. Lightly is the key word. But they’re still structured since you’re swapping out the corporate.

“You’ll see more of those,” he said.

Lightly structured

For the most part, the end-investor for those products remains institutions. But fixed-to-floating products are getting the attention of a greater audience, he said.

“I think certain deals are touching both the retail side and the institutional side.”

Certain firms categorize those deals as plain-vanilla bonds; others see them as structured products.

“If you define a structured product as something with options involved, then it’s not a structured product,” a structurer said.

“But if your definition of a structured product is the use of financial engineering, then yes, a simple interest rate swap like this one is a structured product.”

Those trades originate from an interest rate swap between a bank’s funding desk and its derivatives desk, he explained.

“The funding desk is willing to pay the derivatives desk a floating rate. The derivatives desk hedges it in the market by paying a floating rate in exchange for the collection of fixed-rate payments. It can then package it on behalf of the issuer and the fixed-to-floating rate deal gets sold to investors,” he said.

“The derivatives desk unlike the funding desk never needs money. They’re structuring something. It’s a very simple structure with no options. It’s a swap. But it’s structuring.”

Tough Tuesday

After a strong rally to begin the year, stock prices have declined in February due to fears of a Federal Reserve hiking rates longer in the face of a persisting inflation. Rates climbed as a result. In the beginning of last month, the 10-year Treasury yielded 4.63%. Its rate is now 5.061%.

Volatility as measured by the VIX has also increased from a one-year low of 17 on Feb. 2 to 24 on Friday. But the VIX remains subdued compared to its 52-week high of 37.52 in March of last year.

Tuesday was an ideal day to strike autocalls as the stock market tanked after the three-day weekend posting its worst session of the year on fears of further tightening. And indeed, $31 million out of $53 million of autocalls priced on that day.

Leverage

Leverage notes continued to advance in volume last week. It represented about 50% of total volume versus 21% for autocallables. Those percentages are based on a $258 million notional (excluding the $150 million swap deal) in order to eliminate the skew toward rate products.

“It’s hard to tell why we see more leverage. As rates go up, I guess, issuers have more flexibility into the payoff they can provide and if that’s what investors want, it has become easier to price,” the market participant said.

The top leverage offering last week came from Toronto-Dominion Bank in $30.23 million of 13-month notes linked to the S&P 500 index paying 1.5 times the index gain capped at 22.5% with no downside protection. TD Securities (USA) LLC is the agent.

Leveraged block trades tend to be issued by Canadian banks and distributed by BofA Securities, Inc. toward the end of each month. Such was not the case last week as BofA Securities appeared to have limited its distribution to its own paper and in modest sizes ranging from $10 million to $20 million.

“Maybe it’s the beginning of the year, they have greater capacity,” the market participant said.

In all likelihood, deals coming out of the BofA platform are being sold right now or have been filed late due to the long weekend.

Pick and choose!

Higher rates have also facilitated the pricing over fully principal-protected notes even on the shorter end of the curve thanks to the inverted shape. However, brokers and advisers are now competing with bonds or other safer products.

“We’re seeing more and more market-linked CDs, I mean by that index-linked growth products,” said the market participant.

“For a long time, they were hard to price but not anymore. They can better compete with notes since they offer the FDIC protection against credit risk.”

But Treasuries can do an even better job. Some of the most bullish advisers have complained about low upside potential across various types of structures. One pointed to a 13-month principal-protected note linked to the S&P 500 index with a 100% participation rate and a 5.75% cap.

“I wouldn’t do that,” the market participant said.

A Treasury bill would eliminate exposure to both market and credit risk while showing yields in excess of 5%, he added.

The six-month Treasury rate for instance pays a guaranteed rate of 5.15%. That’s enough to compete with a one-year and one-month note, which does not guarantee the 5.75% cap priced at a meager premium of 60 bps over the risk-free rate.

Stocks, ETFs

The top single-stock-linked note offering last week was a traditional reverse convertible deal issued by Royal Bank of Canada for $12 million. The one-year 10% airbag autocallables linked to 3M Co. pay the fixed coupon monthly. The notes are automatically called if the stock closes at or above its initial price on any quarterly observation date. The principal repayment barrier at maturity is 88%.

UBS Financial Services Inc. and RBC Capital Markets, LLC are the agents.

BofA Finance LLC priced the top ETF-linked notes offering with $16.97 million of 14-month leveraged notes tied to the Energy Select Sector SPDR Fund.

Energy remains the top performing sector for the year and was the only sector not to finish negative last week. The Energy Select Sector SPDR ETF remains one of the most popular underliers in this asset class.

The payout at maturity is triple any ETF gain, subject to a cap of 33.54%.

Investors will be exposed to any price decline.

Volume down

Issuance volume is already negative for the year through Feb. 24.

Sales accounted for $11.017 billion versus $14.98 billion a year ago, a 26.5% drop, according to preliminary data compiled by Prospect News.

The deal count declined by more than half to 2,119 from 4,501.

The top agent last week was InspereX, which distributed Goldman Sachs’ $150 million fixed-to-floating rate deal. Goldman Sachs Group was the top issuer.

Discounting the big swap trade, the leading agent was BofA Securities with $70 million in four offerings. It was followed by UBS and Morgan Stanley. BofA Finance was the No. 1 issuer with $70 million in the four deals it sold.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.