Agents sell nearly $300 million of structured notes in bullish week; mega-caps in focus

By Emma Trincal

New York, Jan. 27 – Structured products issuance volume amounted to $292 million in 116 deals during last week shortened by the Martin Luther King Jr. holiday, according to preliminary data compiled by Prospect News.

Issuance volume in January was weaker than December. Volume through Jan. 22 was at $2.37 billion versus $2.73 billion during the same period last month. It is too soon to determine which way the trend is going at this point as the first three weeks of January are not final figures and the closing of the month not yet known.

A recent update for December showed $7.5 billion in 2,183 deals, outpacing March’s $7.29 billion and setting last month as the best one in 2020.

Trailing 12 months

“I’m surprised that December was the best month last year. We had fewer trading days. People didn’t go on vacation, that’s true, but they took time off at home. On our end, January’s sales are booming. We’re back at the 2019, 2020 levels,” a sellsider said.

As previously reported, 2020 was the best year in the U.S. market, according to the data going back to 2004.

The total for the trailing 12 months through Jan. 22 is up 31.6% to $71.52 billion from $54.35 billion during the previous 12-month period. The number of offerings climbed 30% to 22,285 from 17,149.

Single stocks season

The dominant themes for last week were the robust demand for single stock underliers and a renewed interest for technology.

A total of 88 single-stock offerings came out amid the earnings season with Bank of America Corp., Netflix Inc., Intel Corp., Morgan Stanley, IBM Corp. and Goldman Sachs reporting their fourth-quarter results last week.

After toying with value plays, such as energy or travel stocks, investors resumed buying mega-cap, tech stocks. Once again, gains in the sector were hard to resist.

The Nasdaq Composite ended the week up 4.2% and the relatively tech-heavy S&P 500 index rose 1.9%.

In contrast the blue-chip Dow Jones industrial average finished relatively flat.

Single stocks made for 26% of total volume while multiple stocks (worst-of) accounted for only 5%, a sign that volatility was high enough to do away with worst-of.

“Earnings season is an opportunity that brings a wave of volatility,” the sellsider said.

“You can strike strong barriers, not too long maturities.”

The term reverse convertible refers to short-dated bullet notes with a coupon, which is usually guaranteed.

Just as important as stock deals, issues based on exchange-traded notes made for 27% of the total sold last week. A large offering contributed in part to this result.

Equity indexes were underrepresented compared to their average penetration rate making for 42% of total sales. In the past 12 months, this asset class represents 65% of total issuance volume.

The right call

Once again, autocallables were overwhelmingly the most popular type of product last week, accounting for more than three-quarters of the total in their classic contingent coupon autocalls format. In addition, 10% of total sales came from snowball deals, which pay a cumulative call premium. The rest consisted of a large hybrid deal and smaller digital products.

“Autocalls are flooding the market, which is fine,” the sellsider said.

“But you have to know when to do autocalls and when they’re not the best products to strike.”

“Right now, it’s probably better to do reverse convertibles with a fixed maturity. Six-, nine- or 12-month maximum can price very well.

“You only do an autocall when the coupon is higher than a reverse convertible. Why? Because your duration is unknown. There’s a premium for that. When you buy an autocall, you increase the reinvestment risk, so there’s no point taking that additional risk for a lower coupon.”

Part of the success of autocalls is their cost structure. Whether a note is called in three months or a year, the bank gets the same fee, he noted.

“Autocalls if they strike at the right time, are good for investors. You can earn a nice coupon even if the market is slightly bearish. But they also work quite well for the banks. It’s a way for them to monetize margins. It’s a great incentive for the sellside.

“As long as those autocalls strike at the right level, it’s fine.

“But when the market keeps on going up, it’s less effective. In a bull market, autocall thresholds should be below 100. If the banks set the autocall at par, they don’t take investors’ interest into consideration in my opinion.

“When the market rallies like right now, what’s the point of reinvesting at higher entry levels? You’d be better off buying the stock directly. You don’t want an autocall on a stock that goes through the roof. That’s not the right instrument. You buy the call instead,” he said.

Stock selection

Ideally, investors should buy autocalls on high volatility stocks of companies with a sound balance sheet preferably during a pullback, he explained.

“They should get call strikes below par so if the notes are called, the reinvestment risk is less. Otherwise, you’re better off with a three-month reverse convertible,” he said.

The top single stock last week was Chinese e-commerce platform Pinduoduo Inc., which was used in a $15 million autocallable deal brought to market by Barclays Bank plc paying a quarterly contingent coupon of 11.47% with an 80% coupon barrier and a 20% geared buffer at maturity. JPMorgan was the agent.

Tesla, Inc. was used in five small UBS deals.

Most underlying stocks were technology/communications names such as Zoom Video Communications, Inc., Twitter, Inc., Facebook, Inc., Apple Inc. and Nvidia Corp.

Toronto-Dominion Bank for instance issued $11.95 million of autocallable contingent interest barrier notes with memory interest on Apple, Adobe Inc., Broadcom Inc. and Microsoft Corp.

Barclays Bank priced $10 million of autocallable contingent interest notes on Zoom Video Communications.

Health care or biotech stocks were also in favor.

JPMorgan Chase Financial Co. LLC sold $10 million of autocallable contingent interest notes on Biogen Inc.

UBS AG, London Branch brought to market $10 million of buffered autocallables tied to Viatris Inc., a health care distribution company.

Boeing Co. was also a popular name ahead its Q4 earnings announcement. A record quarterly loss reported on Jan. 27 caused the share price of the plane maker to drop on that day.

Caution: bubbles

When it comes to technology plays, the sellsider advised caution.

“People should continue to stick to the big names, the Amazon, Google, Microsoft that have a sound business model,” he said.

“They shouldn’t gamble with lesser-known high volatility stocks.”

One name comes to mind, which many qualify as a perfect example of a bubble, he added, citing video retailer GameStop.

The stock gained 782% in the past five trading sessions. Starting the year at $17 a share, it closed on Wednesday at $347.51, a stunning gain in less than a month. A short squeeze and record call purchases from investors drawn to trading by social media and new commission-free investment platforms such as Robinhood helped explain the stellar momentum.

“Obviously when there’s such vol., the coupon you get in an autocall is far lower than what you get speculating in the stock,” he said.

“If you do an autocall, you need to pick solid names, a GM or Honeywell, or wait for better entry levels,” he said.

Nasdaq deals

In the index segment of the market, the focus on technology was made visible with the extended use of the Nasdaq-100 index in worst-of deals.

JPMorgan Chase Financial for instance priced the top deal with $35.5 million of five-year uncapped leveraged notes tied to the least performing of the PHLX Semiconductor Sector index, the Nasdaq-100 index and the Nasdaq-100 Technology Sector index.

At maturity, investors will get a minimum of 25% if the reference index is positive or its uncapped gain if it rises above 125%. There is no downside protection.

Rare leverage

This product was the only one to offer leveraged upside, yet Prospect News qualified it as a hybrid structure as it adds a digital component to the return enhancement.

Classic leveraged plays have nearly vanished. While advisers continue to seek enhanced participation, income notes dominate the supply, the data showed.

“At the end of the day, income more than growth is what drives demand,” the sellsider said.

Pricing may also be a challenge.

“Leverage is more problematic when volatility is high,” an industry source said.

“You put on leverage by buying call options, which right now are expensive. They’re not expensive because people are bullish. They’re expensive because volatility is relatively high.”

A market participant said that volatility can play both ways with leverage. It often depends on whether a downside protection is associated with the structure.

“The higher volatility makes the calls more expensive but the puts you’re selling are expensive too. So, it’s not clear cut,” this market participant said.

Small cap, value

Many deals continued to mix the Nasdaq with U.S. blue-chip benchmarks. Barclays Bank’s $25 million of trigger callable contingent yield notes with daily coupon observation due April 25, 2023 linked to the worst performing of the Nasdaq-100 index, the Russell 2000 index and the S&P 500 index was an example.

The 12.15% coupon was based on a 65% American coupon barrier. The barrier at maturity was set at 60%. UBS distributed the notes.

The bid on value remained noticeable as investors continued to expect an economic recovery as more people get vaccinated against Covid-19.

Citigroup Global Markets Holdings Inc. priced the second deal in size with $34.59 million of a 15-month callable fixed-rate note linked to the iShares Russell 2000 Value ETF paying each month 5.03% per year. The issuer may call the notes on any payment date after three months. The barrier at maturity is set at 55%. UBS is the agent.

The top agent last week was UBS with 98 deals totaling $137 million, or 47% of the total.

It was followed by JPMorgan and BMO Capital Markets.

The No. 1 issuer was Citigroup Global Markets Holdings with $55 million in two offerings, or nearly 19% of the total.

Barclays Bank for the year to date is the leading issuer with 65 deals totaling $615 million, a 26% share.

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