Tough conditions in some of Latin America’s biggest economies created a difficult environment for investors in 2016, but Mexico City-based BBVA profited from adversity by offering products that reflected diverse views on the outlook for growth and interest rates.
“Last year was a period of change for Latam investors. Many were looking to do new things in new asset classes,” says Manuel Meza, managing director for global structured solutions at BBVA. “For example, in Mexico we saw the central bank raise interest rates sharply, which gave a boost to the structured note business, while the more positive economic outlook in the US led to a sharp rise in demand for exposure to US equities.”
The regional economy struggled to gain momentum in the early part of the year, held back by Brazil’s worst recession on record, a sharp contraction in Argentina and economic crisis in Venezuela. Meanwhile, the Mexican peso continued the weakening trend seen in 2015, the apparent victim of an oil price slump, speculation over the Trump administration’s trade policy and its status as one of the most-liquid emerging market currencies. The currency ended the year 17% lower against the dollar.
“Early in the year there was a lot of uncertainty in Mexico about how the central bank would respond to the weakening currency,” says Meza. “Most people thought interest rates would need to rise, but there was a lot less confidence about how much, or for how long.”
Those expectations of higher rates resulted in more demand for floating rate exposure, and BBVA responded with a series of five-year medium-term notes (MTNs) linked to Mexico’s TIIE28 interbank lending rate.
The notes contained a novel auto-switchable pay-off feature designed to reflect the uncertainty around the interest rate environment. They were structured with two distinct phases: the first provided floating rate exposure with a cap or a digital cap that was tailored to individual clients’ views on the outlook for rates. After two and a half years, a call option was triggered then the second phase kicked in and the pay-off switched to a range accrual, with the issuer having the right to call the bond at every payment date.
“The product was a good fit for the uncertainty around Mexico’s interest rates early last year. We quickly sold $130 million in notional to three different distributors, as well as through our own private wealth management services,” says Liliana Figueroa, director in the global structured solutions fixed-income team at BBVA. “The high demand reflects a trend we have seen over the past couple of years of increasing confidence in more complex pay-offs, and the distributors are happy because they have been getting good returns.”
The high demand reflects a trend we have seen over the past couple of years of increasing confidence in more complex pay-offs, and the distributors are happy because they have been getting good returnsLiliana Figueroa, BBVA
Elsewhere in Mexico’s fixed-income space, BBVA responded to uncertainty over the direction of energy prices by expanding its bond-referenced MTN programme to include new sectors such as food processing, silver mining and home appliances. Eight of these notes were sold to local distributors, with a combined notional of roughly $40 million and maturity dates ranging between 2019 and 2022. A lack of capital protection meant the notes were more suited to sophisticated investors, but the structures were fairly simple and pay-offs consisted of capped floating coupons.
The focus on Mexican names for Mexican distributors reflected the bank’s regional strategy, which was to offer as much local exposure in each country as possible.
“We have local banks in Mexico, Colombia, Peru, Chile and Argentina, and our strategy is to exploit local capabilities for local clients, often focusing on private banking clients,” says Meza. “So where we delivered exposure to Europe for our clients through BBVA Madrid, we made sure the notes were wrapped in local currency or quantoed to local currency.”
To take one example, BBVA Madrid’s MTN programme provided Colombian institutional clients with a product that enabled asset managers to take capital-protected long positions in large-cap US equities. The notes pay a single coupon linked to the S&P 500 when they mature in 2022, with exposure capped at 30%. The flexo format used for the issuance means the notional is denominated in Colombian pesos but payable in US dollars.
“The structure means local clients can invest in a note issued by a European entity but still pay in local currency,” says José Bernal, executive director for global structured solutions equities at BBVA.
Another trend seen over the past year is the growing demand among Latin American investors for long and short exposure to US equities. This marks a shift from 2014 and 2015, when European stocks were in demand. The bank responded with a listed short-term warrant that combined algorithmically driven signals with calls or puts on US stocks.
“The first thing to understand is that the Mexican warrants market is a little different to its peers, and has become a lot more like a listed note market,” says Bernal. “They can contain a lot more structures and different types of protection and coupons than you would expect from a classical warrant structure.”
BBVA’s best-selling structure last year had a pay-off at maturity in which investors received their principal and a positive coupon if the underlying asset’s closing price hit a low barrier but not a high barrier, or their principal and a negative coupon if the price touched the high barrier but not the low one. The product contained systematic buy-and-sell signals on entities including Nike, AT&T, Verizon and the S&P 500.
Demand was linked to periods of volatility, says Meza. “This type of product sees strong demand during periods of high volatility and less when markets trade flat, as we have seen in recent months,” he says.
The week on Risk.net, 19-25 May, 2018Receive this by email