Structured products weekly tally at $234 million amid continued market turmoil

By Emma Trincal

New York, July 20 – Structured products agents priced $234 million in 96 deals last week amid persisting volatility in the markets, according to preliminary data compiled by Prospect News.

Year, month

Recently updated data revealed that June was the second-best month of the year with $7.33 billion after March’s $8.74 billion. Last month also saw the greatest number of offerings after March at 1,530 versus 1,616, respectively.

The year’s issuance decline is not showing any signs of reversal, however. Through July 15, a total of $44.87 billion of structured products were sold in 9,150 deals, a 15.2% drop from $52.94 billion in 15,824 deals last year, the data showed.

Bid on indexes

Investors continued to solidly bid on equity index notes whose volume represented 84% of the weekly tally, according to the data. Such market share for this underlying category was well above the 68% average for the year to date. Despite banks releasing their earnings last week, the focus was apparently not on stock underliers as stocks represented only 5% of total sales. This weak market share may be surprising at the start of any earnings season. It certainly contrasted with the 18% average for the year to date.

“People are more risk-averse this year. We had a very dismal first quarter. The second quarter was bad too for the most part. The last couple of months are a little better but volatility remains high and the whole year is down. That’s why investors prefer to take positions on sectors or broader markets via indexes,” said a sellsider.

The S&P 500 index finished the week up for the month but down 19% for the year to date. Last week’s market was volatile starting with a three-day sell-off induced by high inflation data and disappointing bank earnings and ending with a rally. The S&P 500 index finished up 0.9%.

No shift in sight

“The most important macro variable of 2022 is arguably the Federal Reserve’s interest-rate hiking campaign,” said a note from Paul Hoffmeister, chief economist at Camelot Event Driven Advisors.

One manifestation of volatility has been the alternance of sell-offs and short-lived rallies.

Hoffmeister attributed the positive sentiment behind each rebound to the hope that the Fed may shift its policy course as it did in the past.

“Unfortunately, it doesn’t appear that the Fed is close to shifting anytime soon,” he said, adding that the economic situation does not call for dovishness,” he said.

Last week’s news that June inflation hit 9.1%, its highest read in four decades, was certainly not going to detract the Fed’s focus on aggressively raising rates leading this economist to predict “more pain to come.”

Expectations of a global economic slowdown are also driving the negative sentiment, with the inversion of the yield curve adding to the overall uncertainty.

Yet the market is rallying now and then, enough to convince some that the bear market is now over.

Autocalls down

Some traders urged caution.

“The market is faking up before it makes a much more important and dramatic move down,” said Steven Jon Kaplan, portfolio manager and founder of True Contrarian Investments.

With rising uncertainty, one would expect renewed interest for autocallable structures, which provide downside protection and limited upside, both ideal in a range bound market. Instead, the market share of those products has significantly diminished to 43% this year through July 15 from 65% last year. Volume fell from $34.26 billion to $19.38 billion this year.

The main reason for this decline is well-known: amid this year’s sell-off, many notes have not been called leaving investors and advisers alike without reinvestable proceeds.

Leverage up

Leveraged notes have benefited from the rise in interest rates and increased volatility.

While leveraged notes with 100% principal protection make for less than 1% of total sales this year, their notional amount has more than doubled to $307 million from $148 million a year ago.

Meanwhile, enhanced return notes with barriers or buffers have seen a 23% rise to $7.84 billion from $6.38 billion last year.

“Growth notes are becoming very attractive,” a market participant said.

“The amount of leverage you get is higher especially on five-year worst-of.

“With the high volatility, credit spreads start to move higher. For issuers, funding becomes too costly. The banks are willing to offer better terms when they need the capital. It’s becoming too expensive to borrow.”

Based on data compiled from Markit, the average five-year credit default swap rate for the big U.S. banks was 53 basis points on Jan. 3. On Wednesday, the same average was 103 bps. The extracted data originates from the CDS spreads of Bank of America Corp., Citigroup Inc., Goldman Sachs Group Inc., JPMorgan Chase & Co. Morgan Stanley and Wells Fargo & Co.

Shorter plays

The rise in volatility this year has allowed banks to shorten the tenors of the notes they issue. While the average tenor during last year’s first half was 3.5 years, it is now 2.65 years, according to Prospect News data.

From the investors’ standpoint, short durations have often been preferred. However, longer dated notes were popular for defensive advisers seeking less risk and better terms.

“It’s a little bit different now that we’re already in a bear market,” a source said.

“I see a push toward shorter tenors. Because we already had a pullback, clients are more inclined to go in and out. They seem to think that if they have a short-term exposure, there won’t be enough time to get into trouble, so they tend to move toward short durations. It’s a little bit odd because historically, you have much less downside risk with a four- or five-year note. Maybe they’re slightly more optimistic now than they were earlier this year.”

Squeezing more juice

In their income notes, issuers are routinely employing features that add risk premium. A common one is the use of a discretionary call, in place of an autocall. More recently structurers have included American barriers on the coupons (daily observations).

Last week offered an example combining both solutions for a higher coupon.

Canadian Imperial Bank of Commerce issued $16.97 million of trigger callable contingent yield notes with daily coupon observation due Oct. 17, 2025 linked to the worst performing of the Dow Jones industrial average, the Russell 2000 index and the S&P 500 index.

The notes will pay a contingent quarterly coupon at an annual rate of 12.68% if each index’s closing level is at least 70% of its initial level on every trading day during the observation period.

The notes are callable at par plus any coupon otherwise due on any quarterly observation date.

If the notes have not been called and each index finishes at or above its 70% coupon barrier, the payout at maturity will be par plus any final coupon otherwise due.

If the worst performer finishes below its coupon barrier but at or above its 55% knock-in level, the payout will be par. Otherwise, investors will lose 1% for every 1% that the worst performer finishes below its initial level.

UBS Financial Services Inc. and CIBC Capital Markets are the agents.

Issuer calls

Investors tend to accept more complexity and more risk when they can obtain much better terms. But it does not mean they favor those features.

For instance, discretionary or “issuer” calls are far from popular, a sellsider said.

“People like autocalls more than issuer calls because it’s not always clear why the issuer would call the notes,” he noted.

“Nobody knows what drives an issuer’s decision to call the notes. When they think they can make more by holding on to the position, they will.

“Sometimes the underlying is up quite a lot, and they still don’t call. When they do that and the stock crashes at maturity, investors are not going to like the experience.

“The autocall is rules-based. Even if it pays a slightly lower coupon, it’s more predictable.”

Commodities

Despite a rising U.S. dollar and recession fears, most commodities have gained this year as investors are seeking inflation hedges. While gold and real estate have posted negative performances, energy has been driving the outperformance of commodities as an asset class, said Jim Wiederhold, associate director, commodities and real assets at S&P Dow Jones Indices, in research note.

The S&P GSCI index is up 34.2% for the past year versus minus 9.3% for the S&P 500 index.

This performance led to a surge of commodities-linked notes issuance this year, up 158% to $729 million from $282 million last year.

For last week, only two small commodities buffered digital deals priced for $2.08 million and $2.5 million. They were issued by JPMorgan Chase Financial Co. LLC and linked to Brent crude oil.

Much bigger trades have been spotted recently such as GS Finance Corp.’s $97 million on the Bloomberg Commodity index last month.

The persistent use of single indexes versus worst-of was a clear trend last week.

Out of a $196 million of equity index-linked notes, $56 million were worst-of versus $139 million tied to one index, reflecting a 24% and 60% split, respectively, in market shares.

The largest single index note was tied to the Russell 2000 index and issued by JPMorgan for $15 million.

The top agent last week was UBS with $95 million in 42 deals, or 40.4% of the total.

It was followed by JPMorgan and Morgan Stanley.

The No. 1 issuer was JPMorgan Chase Financial with $47 million in 14 deals, a 20.2% share.

© 2015 Prospect News.
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