Structured products issuance at $228 million in post-holiday week; July marks progress

By Emma Trincal

New York, July 17 – Agents priced $228 million of structured products last week through 79 deals, a decent number given that it was the first full week of the month after the Fourth of July holiday. In addition, the tally should be revised upward next week when all deals are fully accounted for.

July as a whole is encouraging.

“July is usually a slower month. The fact that the Fourth of July fell out on a Thursday kind of took everybody out of production for that week and put a damper on sales, at least for us. That said, last week was a different story. People are back. Deals are getting done. The phone is ringing again. We’ll see how July turns out,” said a sellsider.

July so far

The month is turning out pretty good so far. For the first time since May, volume is up from a year ago.

Agents in July through Friday, July 12, sold $720 million, a 13.8% increase from $633 million during the same period a year ago. For full month counts, only May so far exceeded volume (+5.6%) from the previous year. The other months were down with January and February showing declines of more than 40%. June also suffered a drop, down 20.3% from last year.

To be sure, the month is not over yet, but given that current numbers are preliminary and subject to increase, there is room for hope for a period of the year, which tends to be slow in general as is August.

Year so far

The year-to-date total still showed a decline, but the gap with 2018 is narrowing as the year advanced. This is because last year saw unusually big block trades in the first quarter. While the tally by mid-April this year was more than 38% lower than last year, the gap is now much lower, in fact about a third thinner. Agents priced $24.31 billion this year through July 12 versus $32.08 billion last year, a 24.2% decline.

This may have to do with a stock market rallying 9.3% since the beginning of June on hopes of rate cuts, a message sent by Federal Reserve chair Jerome Powell since the beginning of last month, which has offset the uncertainty created by the trade war between the United States and China. After dropping in May, the stock market is up nearly 20% for the year.

The rally hit a new momentum last week when the Fed told Congress that a rate cut was in the cards for its FOMC meeting at the end of the month, pushing all three major U.S. benchmarks to new record highs.

The S&P 500 index closed for the first time above the 3,000 level.

Structures

Income deals prevailed last week with 46% of total notional, versus 27% for leveraged deals, according to the data.

This marked a contrast with the yearly average of about 35% each.

Usually most income deals are autocallable contingent coupon notes with one or multiple underliers in the case of worst-of. Last week’s difference was a surge in so-called autocallable snowballs, which pay a cumulative call premium upon the call event only. Those accounted for more than 22% of the total against 24% for the contingent coupon autocalls.

As a comparison, the yearly average breakdown shows much fewer snowballs: less than 4% of the total against 30.5% for autocallable contingent coupon notes.

One direct explanation, at least for last week, was that the No. 1 deal in excess of $40 million fell into the snowball product type.

But there is also a trend behind those numbers.

“We’re doing more snowballs than before. We have a group doing them. People heard about those structures that tend to pay a bit more. We make sure we have one or two on our monthly calendar for people who are interested in them,” the sellsider said.

But the firm has not adopted a new strategy in pushing those deals.

“Most of our snowballs are one-off trades for our financial advisers constructing their own book.”

Snowballs autocalls unlike contingent coupon notes are not technically income product since investors do not have the opportunity to earn a coupon throughout the life of the notes, he observed.

While they are broadly used as fixed-income supplements, his firm categorizes them as growth products since they pay a cumulative call premium and not a coupon.

They also put principal at risk.

“We try to make sure clients understand they’re not a typical replacement for a fixed-income portfolio,” he added.

“Because there is a principal barrier, there is a fair amount of risk.

“One way to reduce it is to offer longer-dated deals. Statistically, the market is less likely to finish down over a long period of time.”

Red and black bets

Single-stocks were not last week’s focus with only 6.4% of total volume, approximately half of the yearly average in terms of market share. Equity indexes dominated the flow with 85% of notional.

As always, a great deal of equity indexes or broad-based trackers through exchange-traded funds were used in worst-of products. There were $37 million issued in worst-of last week, out of which only $3.33 million via single stocks. Those were two deals, one using Boeing Co. and Southwest Airlines Co., the other eHealth, Inc. and Lyft, Inc.

As always, the S&P 500 index was the most widely used index either on a stand-alone basis or in combination with other major U.S. benchmarks such as the Dow Jones industrial average and the Nasdaq-100 index.

“The redundancy is amazing in the new issue business,” said a broker, who is involved in the secondary market.

“You only have two or three major indexes. The S&P is everywhere. It’s highly diversified. Occasionally you get the Nasdaq and the Euro Stoxx.

He compared deals tied to equity indexes to red and black bets in roulette, which offer the greatest probabilities of wining smaller gains that bets on individual numbers.

“I look at the S&P, the Dow Jones as black and red bets as opposed to individual stocks.

“The individual numbers pay more because you’re less likely to win.

“But investors don’t have time to analyze stocks. They’re too confused about what the market is going to do. They just buy the broader benchmarks. They’re not going to make as much. But for a lot of people, that makes sense,” he said.

Barclays, top deal

Barclays Bank plc issued $42.84 million of six-year autocallable market-linked step-up notes tied to the S&P 500 index. The notes were distributed by BofA Merrill Lynch.

The notes will be called at par of $10 plus an annualized call premium of 5.8% if the index closes at or above the initial level on an annual observation date.

If the notes are not called and the index finishes above the step-up value, 135% of the initial level, the payout at maturity will be par plus the index gain.

If the index finishes at or below the step-up level but at or above the initial level, the payout will be par plus the step-up payment of 35%.

There is a 15% downside buffer.

“It’s different for a snowball,” the sellsider said.

“You get a buffer instead of a barrier. Also, you typically have a quarterly, not an annual, observation. The longer the duration between autocallable events, the less likely you are to get auto called,” the sellsider said.

Market-linked step-up notes are best-selling products within the BofA distribution channel. One appealing feature is the uncapped one-to-one upside exposure at maturity if the index finishes above the step-up value. In this case, investors will not be capped if after six years the S&P 500 index is up more than 35%.

“There’s an element of marketing gimmick when it comes to the uncapped upside at maturity,” he said.

“The only way you get it is if you’ve gone through the past five years without ever being called. The index would have to rise by more than the cumulative call premium in the last year for this scenario to happen. Highly unlikely...”

From the underwriter’s standpoint, the pricing makes sense.

“It’s a one-year out-of-the-money call option at 135%. It’s fairly cheap.”

Buying a one-year out-of-the money call option with a current (at-the-money) price of 100 with a strike price of 135, would be the equivalent of betting that the index could surge by 35% or more in only one year. Since it’s improbable, the option is not expensive.

The second deal came from Royal Bank of Canada in $26.93 million of 14-month digital notes on the S&P 500 index. The structure allowed for a 13.06% digital payout even if the index fell by up to 15%. Beyond the 15% threshold, investors will lose 1.1765% for each 1%.

Top players

The top agent last week was Bank of America with $61 million sold in only four deals, or 26.9% of the total.

UBS followed with $41 million in 44 deals. Royal Bank of Canada was third.

Barclays Bank plc was the No. 1 issuer with $45 million in three offerings, a 19.9% share.

Barclays remained the top issuer for the year with $3.84 billion in 948 deals, a 15.8% share.

JPMorgan Chase Financial Co. LLC followed with 12.9% of the total market, or $3.15 billion issued in 1,221 deals.

“July is usually a slower month. The fact that the Fourth of July fell out on a Thursday kind of took everybody out of production for that week and put a damper on sales, at least for us. That said, last week was a different story. People are back. Deals are getting done. The phone is ringing again.” – A sellsider

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