January structured products issuance outperforms year ago; week led by stock underliers

By Emma Trincal

New York, Feb. 24 – Structured products agents sold $162 million in 145 deals during the holiday-shortened week, according to preliminary data compiled by Prospect News. Single-stock deals prevailed in the form of autocallables and digital notes.

The most recent issuance volume update revealed two items of good news: January was a better month than a year ago; issuance volume year to date exceeds last year’s notional.

Agents last month priced $7.65 billion, a nearly 9% increase in volume from January 2020’s $7.03 billion.

The number of offerings rose as well to 2,124 from 1,906, a more than 11% gain.

“We had a good January. How do I explain it? I don’t. It’s always difficult to explain why the market is up. One sure answer is that you have more buyers than sellers,” said a sellsider.

“February so far is also good. It’s in line with a year ago for us.”

Good January

A distributor was not surprised by last month’s data.

“January was still a good story,” he said.

“Stocks are at all-time highs. Rates at all-time lows. I want some income...how do I achieve it? I want protection...how do I get it? It’s a good rationale for structured products.

“On top of that, you now have more adoption of those products by retail investors, more accessibility through technology.

“All of this is very positive.”

Yearly progress

Sales for the year through Feb. 19 are up 4.4% to $10.17 billion from $9.74 billion. While modest, the year-to-date volume increase may be greater after February’s final update although it’s premature to make that call given that February 2020 was a strong month, the third-best one of last year.

For the trailing 12-month period, volume is up 25.6% through Feb. 19.

Agents priced $72.66 billion in 22,886 deals from Feb. 20, 2020 to last Friday versus $57.85 billion in 17,928 offerings during the 12 previous months, the data showed.

Big basket deal

Last week offered familiar patterns: autocallables made for 72% of the total and leverage was subdued.

The other structures were mostly digital products. The distribution by asset class was more unusual with stocks (single names and baskets) accounting for two-thirds of total sales. The other third came from equity indexes.

While popular, stock underliers don’t usually hold such large market shares. The volume was mainly inflated by a single deal which topped the list.

UBS AG, London Branch priced $44.88 million of five-year autocallable contingent coupon notes linked to a basket of 10 stocks consisting of Apple Inc., Amazon.com, Inc., Facebook, Inc., Alphabet Inc., Microsoft Corp., Netflix, Inc., Nvidia Corp., Qualcomm Inc., Tesla, Inc. and Twitter, Inc. The notes will pay a contingent quarterly coupon of 8% per annum based on a 70% coupon barrier. The barrier at maturity is 60%.

Durable trend

But the appeal of stocks is an ongoing trend.

“The market going up has been helping issuance this year,” the sellsider said.

“But when the market goes up, volatility may not be that high.

“Fortunately, there is a shift in structured products as investors are buying new stocks, more volatile single stocks or dedicated baskets. We see less of index products.”

The bull market reinforces that trend.

“People are more comfortable buying more speculative assets. They’re not as cautious about going into stocks rather than indices.

“That’s where we see the support behind the volume: more deals trading on stocks.”

The distributor said he sees a growing number of baskets in the market.

“Mass customization is out there. Now advisers can design their own baskets. What if you want exposure to the Nasdaq but not the entire index? What if you just want to pull out the names that are the most relevant for you.

“You now have the tools to do that. That’s the beauty of customization through technology. Why should you use an index and pay a licensing fee when you can get a structured note tied to your own basket?”

Buffered autocalls

Buffers were used more than usual last week. They were seen on autocallable as well as digital notes. The gearing was the necessary tool to make pricing work.

JPMorgan Chase Financial Co. LLC issued $10 million of one-year autocallable contingent coupon notes on Qualcomm Inc., which will pay a 12.9% quarterly contingent coupon based on an 80% coupon barrier.

The notes are automatically called above initial price on a quarterly observation date. The payout at maturity is par unless the stock finishes below the 80% buffer level, in which case investors will lose 1.25% for each 1% stock decline beyond the 20% buffer.

Morgan Stanley Finance LLC issued the same structure for the same size on another deal tied to China internet stock Pinduoduo Inc. The only difference was the annualized coupon rate of 35.28% per annum and the monthly frequency for the payment and call dates.

JPMorgan was the placement agent on both deals.

Two buffered digitals

Another example of the buffer use was seen in a couple of digital issues, which hit the market last week.

The products were designed as “in-the-money” digital structures allowing investors to get paid if the final index price is above a strike set below the initial level. Those products are popular because they give more than just principal protection when the underlying is negative yet above the downside threshold. For the same reason however, the coupon tends to be lower.

One of those larger digital issues was GS Finance Corp.’s $19.58 million of 18-month notes linked to the S&P 500 index. The issuer offers an 11.2% payment if the index is above 90%. The 10% amount is the size of the geared buffer on the downside with investors losing 1.111% for every 1% beyond it.

Goldman Sachs & Co. LLC is the underwriter, and JPMorgan, the placement agent.

The other came from Canadian Imperial Bank of Commerce in an $11.5 million issue of 13-month digital notes linked to the S&P 500 index. The downside threshold was set at minus 25%, hence, increasing the odds of getting a positive return. It was also more protective with the geared buffer size at 25% with a 1.333 multiple. As a result, the 4.2% digital payout was lower. CIBC World Markets Corp. is the agent.

Inflation fears

Last week’s stock market saw a pause from its recent all-time highs as investors were focusing on higher yield and inflation for the first time in a while. The S&P 500 index finished the week down 0.7%. Technology stocks dropped led by Apple after a report revealed that the company was the target of a new lawsuit from the European Union.

“Tech was down last week because the P/Es are extremely high. More people are thinking about the risk of a potential blowup,” the distributor said.

But higher-yields and inflation anticipations rather than tech were center-stage last week.

The 10-year Treasury yield moved up to 1.35%. The rise has been consistent for the last couple of weeks. On Feb. 24, the yield was close to 1.4%, a sharp contrast with 0.917% at the beginning of the year.

Some analysts see inflation as unavoidable.

“Inflation will be out of control by year-end,” said a recent note by Dick Bove, chief financial strategist at Odeon Capital Group.

“The Fed is printing money at a rapid pace for one reason – to cover the federal deficits. This technique has generally been inflationary, globally, wherever it has been done.”

Higher is better

Higher yields may not be good for the stock market, at least initially since investors may be moving into less-risky assets if yields become attractive enough.

But rising yields could be a silver lining in some abandoned corners of the structured products market, such as market-linked certificates of deposits (MLCDs) for instance.

“If rates do go up, we’ll be able to do MLCDs and principal-protected notes again,” the sellsider said.

“We stopped everything last year. You can’t price full capital protection. Rates are too low. If indeed rates continue to go up in 2021, we could look at bringing back capital protection to our clients.”

This may not happen overnight though.

“The 10-year would have to rise to 2% to 3%,” he said.

But there is always demand for protection. Only supply was missing so far, he explained.

“You have two types of investors. The conservative investor and the risk-taking investor. They both have to be catered to,” he said.

Post-Covid world

More investors are predicting if not a bear market, at least a correction soon.

Slow vaccination, new Covid-19 variants and economic slowdown have been in focus. Now inflation could be the trigger.

But it may not be a bad thing for structured notes, as evidenced by the strength of the issuance pace last year in March when the stock market crashed, the distributor noted.

“As yields go up, stock prices aren’t going to be propped up as much,” he said.

“With the Fed committed to keep rates low for a long time and the trillion-dollar stimulus, people are starting to think about inflation again.

“We may see a rocky post-Covid market recovery. We are going to see drawdowns. But it will be healthier.

For structured notes, a correction with volatility soaring may be helpful.

“It’s a net positive for our market.”

UBS was the top agent and issuer last week with 138 deals totaling $90 million, or 55.4% of the total.

It was followed by JPMorgan and CIBC World Markets Corp.

Barclays is the No. 1 issuer for the year to date with $1.73 billion in 251 offerings, a 17% share.

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