Covid-19-related slowdown hits structured notes sales in April; volume down 43% from March

By Emma Trincal

New York, May 6 – For the first time in weeks, the effects of lockdowns, business shutdowns and economic slowdown caused by the novel coronavirus pandemic are beginning to be felt in the structured notes market, according to preliminary data compiled by Prospect News.

Last week, which finalized April, saw $665 million of structured notes issued in 233 deals. These figures however remain subject to upward revisions as the data is not final.

Weaker April

This brings April’s preliminary tally to $4.11 billion, a 43% drop from $7.24 billion in March.

The deal count is down 38.5% to 1,322 from 2,151.

Even with the unavoidable lag between the time deals are filed with the Securities and Exchange Commission and the collection of final data, the drop is certain to mark a turning point.

March was the best month of the year.

It also was the second-best month after February 2008 since the first database records going back to 2004.

April’s sales are significantly cut compared to the three other months of the year, all above $7 billion each.

February was the second-best month with $7.23 billion followed by January with $7.03 billion.

Volume last month was flat versus $4.25 billion a year ago.

But last year really picked up in momentum starting in May. If a decline persists this year, the advance observed so far from last year could be eroded fast.

The year so far though the end of April is at $25.62 billion versus $15.02 billion the previous year, a 70% increase. While spectacular, the 70% surge is already much lower than the doubling size recorded week after week since March.

This could be either the result of a lag in capturing live data or the sign of a startling slowdown, or both.

Leverage push

One recent trend is leverage catching up with income deals. On average this year, 45% of issuance volume went into autocallable sales versus 28% for leverage.

Last week was more balanced: approximately 30% of the bid went to leverage and autocalls evenly.

Single-stock deals declined in volume last week, including worst-of deals on single names.

In contrast, equity indexes accounted for 80% of the total.

“We still see people buying single-stocks for more tactically oriented deals,” said a market participant.

An example was JPMorgan Chase Financial Co. LLC’s $11.17 million of three-year autocalls on the least performing of Facebook, Inc., Alphabet Inc., Microsoft Corp. and Amazon.com, Inc. All four companies reported earnings last week.

Similarly, Morgan Stanley Finance LLC offered a tactical play on oil by pricing a small autocallable deal tied to the worst of Exxon Mobil Corp. and Chevron Corp.

Leveraged notes with barrier or buffers represented two-thirds of total leveraged products sales last week, the rest in leveraged notes with full downside risk.

This distribution is the exact opposite of the year’s average, reflecting increased caution amid the uncertain environment.

Schizophrenic market

The market is not really in synch with perceptions of an economic slowdown. If structured products issuance dropped in April it was certainly not the case for the equity markets, which registered their best month since 1987.

The S&P 500 index finished the month up 13%.

Last week in the stock market was another one of those “up-and-down” weeks, starting with a robust rally yet falling on Friday amid fears of a second wave of infections and concerns over a trade war with China.

Some see a pattern between the pandemic cycle – from the rising death toll to a peak followed by a drop in the number of cases – with investors’ appetite for structured notes.

“The virus in Europe began to spread a few weeks after China. The U.S. was hit three weeks later. Everything comes with a slight delay,” a sellsider said.

In Europe, January and February were “fantastic” for structured notes issuance while March was only “OK.” For the United States, March was the “hottest” month and things are beginning to slow now, he said.

Autocalls below par

Sources are pointing to some difficulties in the normally robust autocall market, seen now as struggling.

“Many products with autocallable features were sitting at mark-to-market well below par,” the sellsider said.

“Maybe the more resilient tech stocks were at par and got called.

“But if you were Boeing or General Motors, not to mention an energy or airline stock, no chance of getting called. You were not only below par but also below the barrier.”

Boeing Co. lost two-thirds of its value this year. General Motors Co. saw its share price drop 40%.

“For people right now, getting the coupon is not the priority. The only thing you care about is to get your principal back. You want to be called,” he said.

Declining demand

This leaves less money on the table for reinvestments in new structured products offerings, he said.

“People don’t necessarily have huge allocations to structured products in general. If they allocate 5%, you can be sure that 80% of it is below par. So, you can’t issue new deals with that,” he said.

“It’s too bad because with volatility so high, there are so many great opportunities. Investors even if they wanted to can’t really capture those terms. Their money is still tied up.

“Those who have the money are scared about the wild roller coaster ride in the market. They just want to sit on the sidelines.”

The picture was a little bit different in April as the market surged. But many investors remain skittish. The Covid-19 toll on the economy and the unprecedented rise in jobless claims begin to affect sentiment in a negative way despite the stimulus, he noted.

“There is still hope for a V-shape recovery,” he said.

But the pandemic is far from contained.

It would require a quick return to normal. With 30 million jobs lost in the United States in the last six weeks, “investors are reluctant to invest new money in structured products. It will take time for them to change their minds,” he said.

Red flags with dividends

Issuers themselves are feeling some pain.

“A lot of companies had to cut their dividends. When they do, it’s not good for pricing,” this sellsider said.

Congress last month passed the Coronavirus Aid, Relief, and Economic Security (CARES) Act to assist businesses during the crisis. The new law prohibits public companies that receive Federal loans under the Act to use any of it to repurchase their own shares and to issue dividends.

Since dividends are used for the pricing of equity derivatives – along with the premium captured from shorting options – any cut in dividends may have an impact on pricing new deals.

Dividend drops may also compromise the hedges issuers put in place for their existing positions, especially when those hedges have to be managed periodically as a result of a call option.

On Tuesday, the Walt Disney Co. announced that it will forgo payment of a semiannual cash dividend for the first half of fiscal 2020, given the “significant operational and financial disruption” caused by Covid-19.

Disney is not alone in the camp of companies suspending or cutting dividends. General Motors suspended its dividend last week. Some energy companies cut theirs recently as well, for instance Schlumberger NV and Noble Energy Inc.

CARES in charge

Other factors impacting volume may be the unintended consequences of the CARES Act, which provides issuers with an incentive to shift some of their focus away from derivatives into more stable loans, according to a bank analyst.

Issuing equity derivatives involves hedging risks with costs.

Autocallables for instance require to be hedged on a regular basis.

Now banks may be really tempted to shift their focus toward lending money to small businesses with the guarantee of the Federal government, according to a source.

“They’d be crazy not to do that,” said Dick Bove, chief financial strategist at Odeon Capital Group.

“They can lend money and pick up new customers.

“The government is willing to take 100% of the risk.

“Why wouldn’t they?

“The government is restructuring the flow of debt in this country.”

It remains to be seen how or whether this new activity may have lasting consequences on issuance of structured notes, a sector that is dwarfed by other segments of the bond markets.

Goldman shines

Last week’s top deal was GS Finance Corp.’s $87.35 million of 15-month digital notes tied to the S&P 500 index.

If the index finishes at or above minus 10%, the payout will be par plus 13.9%.

If the index return is less than negative 10%, investors will lose 1.1111% for every 1% index decline beyond 10%.

GS Finance printed the second top deal with $81.58 million of 15-month notes on the S&P 500 index.

The payout will be par plus three times the index gains up to a maximum payout of par plus 23.7%. Investors are fully exposed to losses.

The top agent was Goldman Sachs with $221 million in 26 deals, or 33.2% of the total.

It was followed by UBS and Morgan Stanley.

Goldman’s issuing arm, GS Finance, was the top issuer with 228 million in 28 deals, or 34.32% of the total.

GS Finance is now the second largest issuer for the year with $3.12 billion in 902 deals. The top one is Barclays Bank plc, which brought to market 733 offerings totaling $3.81 billion.

© 2015 Prospect News.
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