Structured notes issuance $535 million for the week; tech rally feeds bid for growth

By Emma Trincal

New York, Aug. 26 – Structured products agents priced 174 deals totaling $535 million the third week of August, according to preliminary data compiled by Prospect News.

Autocallables continued to dominate the flow with 62% of total notional versus 35% for leveraged notes.

However, leveraged notes were among the top block trades that priced last week.

The use of exchange-traded funds as underliers was more significant than usual last week, making for about a quarter of total volume, a share in line with single-stocks-linked notes issuance. It was largely the result of two top deals using this underlying category of assets. As a result, the representation of equity-linked notes, making for 39% of total sales, was considerably lower than the annual average of 68% for this asset class.

In the equity markets, once again, the mega-cap tech stocks drove last week’s rally, pushing the S&P 500 index and the Nasdaq Composite into new record highs. Apple hit the $2 trillion market capitalization mark and the tech bull market continued to appear unstoppable, making investors slightly more inclined to score capital gains.

Month, year

Volume for the month rose nearly 20% from July with $2.21 billion sold through Aug. 21 versus $1.85 billion during the same time last month, the data showed. The number of deals so far is about the same at 707 versus 704. As numbers are subject to upward revisions, it is likely that August will be stronger than July once the data is finalized.

“We had the Democratic Convention last week, the Republican Convention this week...People are starting to see the volatility as it relates to the U.S. Elections,” said a sellsider.

“I also think investors are not on vacation as much this year.

“The headlines and the market run up are calls for action.

“People are planning to rebalance their portfolios ahead of major changes. The stimulus, the future of corporate taxes, the progress in Covid-19 vaccines, all this is unknown right now. There are just a lot of uncertainties. I see an increase of issuance leading to this Election.”

Volume for the year reached $43.95 billion, a 46% increase from $30.1 billion last year. Meanwhile the number of deals soared 38% to 13,494 from 9,787.

Size and deal count

While the bulk of volume last week remained in income-oriented autocallables, leverage commended fewer but much larger deals. Autocallables accounted for $332 million in139 deals. Total sales of leveraged notes amounted to $193 million in only 17 offerings.

While these differences in sizes between income and growth are typical, they may also point to a renewed interest in growth-oriented structures.

Momentum propelling the shares of Apple Inc. 70% higher for the year and Amazon.com, Inc. jumping 85% during the same time is highly visible, the sellsider said, adding that demand for leverage tied to those names is likely to increase.

The bid for growth

Last week’s top deal illustrated a relatively aggressive play on technology by skipping the downside protection.

GS Finance Corp.’s $56.69 million of 13-month leveraged notes tied to the Technology Select Sector SPDR fund will pay at maturity 1.5 times the ETF gain, capped at 27%.

“With this bull run, there’s a real incentive to capture the returns of tech stocks,” this sellsider said.

“More people now are thinking that instead of capping their return on one single stock, they’ll go with a worst-of on those big tech names so they can get leveraged uncapped returns.

“It goes like this: let me have a two- or three-year note tied to the worst of Apple and Microsoft with a 70% barrier and 1.2 to 1.3 uncapped upside.

“People seeking growth with a level of protection find this kind of story captivating.”

Another leveraged deal notable in size was UBS AG, London Branch’s $30.63 million of 13-month leveraged buffered linked to the S&P 500 index. The payout at maturity is 1.4 times any index gain, up to a 24.15% cap.

Investors will receive par if the index falls by up to 15% and will lose 1.1765% for every 1% decline beyond 15%.

The S&P 500 index has become an indirect bet on the fastest-growing sectors in the U.S. economy. Information technology, which includes Microsoft and Apple, as well communications services (Alphabet, Facebook) have a combined weighting of 40%.

Valuations

On the other hand, other investors, concerned about the stretched valuation of Big Tech may prefer to monetize the volatility for higher income or even more safety,” said the sellsider.

Some analysts believe that most of the tech rally is driven somewhat by the Covid-19 pandemic, as it has forced people to buy online during the lockdowns. A return to normal could reduce online spending and trigger a sell-off.

“Personally, I’m not in that camp, but some people want to play it safe,” he said.

Digital and autocall

An example of the search for more protection in the highly volatile tech sector may include some hybrid structures. GS Finance last week offered an example with $20 million of two-year autocallable worst-of notes linked to Amazon.com, Inc., Microsoft Corp., Alphabet Inc. and Facebook, Inc. The structure combines a single automatic call after one year followed by a deep in-the-money digital payout. The call premium if all stocks are at or above their initial price on the call date will be 16.3%. Otherwise, the payout switches to a 32.6% digital return paid if the worst-of finishes at or above a 60% barrier.

The “more protective” element is the autocallable opportunity but more significantly, the deep barrier, he said.

Memory and guarantees

“If people are skewing income, they’re skewing toward more conservative structures,” he said.

“If you want to buy into those Apple or Amazon, you want a little bit less risk. Instead of contingent coupon, clients recently tend to ask for guaranteed coupons or contingency with memory. They’re looking for more defensive features to mitigate the risk of short-term pullbacks.”

A structure with a “memory” will pay the current call premium or coupon at a given observation date when the contingency criteria are met. In addition, it will also distribute previously unpaid coupons or premiums from previous observations, in which conditions failed to be met. As a result, the payments accumulate, and investors may “catch up” with missed opportunities.

“If Apple or Microsoft can drop 30% in a three-month or six-month time, the expectation is that they won’t over the long term,” the sellsider said.

“So, you’ll see more reverse convertibles with a 12% guaranteed coupon instead of a 20% contingent coupon. It’s less income, but it should alleviate your fear of a pullback.”

Yield with protection

Income continued to be in demand for the same reasons. Low rates are the main culprit pushing investors to take on more credit risk or market risk depending on the asset class they are allocating to.

“If you’re an income investor, dividend yields have fallen below 1%. Stocks with high yields like Exxon, Chevron with 6% or 8%% dividends have had a terrible price performance because of the oil market. On the bond side, the 10-year Treasury is at 0.7%, corporate bonds are not yielding much or yielding zero after inflation. Even junk bonds are only yielding 4.5% to 5% and you’re taking a tremendous amount of credit risk. So, getting a structured note even with an 8% coupon is great,” a market participant said.

GS Finance issued the second deal of the week with $34.9 million of one-year callable notes linked to the Invesco S&P 500 Equal Weight exchange-traded fund. The notes pay a monthly coupon of 4.35% per annum and can be called monthly after three months at the discretion of the issuer. The barrier at maturity is 55% of the initial price.

“This is a low yield, but your coupon is fixed,” the sellsider said, adding that such deal illustrated investors’ search for safety at a time when valuations are high.

“The 55% barrier offers some decent protection. The exposure to the equally weighted S&P also gives you some comfort if you’re concerned about the heavy tech weighting in the S&P.

“It’s a way to invest with a level of protection and income that can easily fit your allocation.

The top single-stock deal came from Morgan Stanley Finance LLC with $20.35 million of three-year autocallables on Boeing Co.

The notes will pay a quarterly contingent coupon of 13% per year based on a 50% coupon barrier.

After six months, the notes will be automatically called at par plus the contingent coupon if the shares close at or above the stock’s initial price on any quarterly observation date.

The barrier at maturity is 50% as well.

Last week’s top agent was UBS with 84 deals totaling $176 million, or 32.9% of the total.

It was followed by Goldman Sachs and Citigroup.

The No. 1 issuer was GS Finance Corp. with $161 million in 18 offerings, a 30% market share.

GS Finance so far is also the top issuer for the month.

For the year to date, Barclays Bank plc kept its top issuer ranking with $6.51 billion in 1,350 deals, or 14.8% of total sales.

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