Sell-off to strengthen demand for structured notes, sources say; weekly tally at $214 million

By Emma Trincal

New York, Jan. 26 – As the bearish start of the year continues with growth and tech stocks leading the drawdown, industry participants showed a relatively optimistic outlook on the sales of structured notes as uncertainty and the need for protection are rising.

During the holiday-shortened week, agents priced $214 million in 68 deals, according to preliminary data compiled by Prospect News. Figures will be revised upward as more deals get filed with the Securities and Exchange Commission. Updated data for the previous week ended Jan. 14 pointed to a total of $1.55 billion of notes issued in 332 offerings.

The market closed Monday for the Martin Luther King Day holiday. During the four following trading days, the stock market fell for a third-straight week with the Nasdaq dropping 7.6% and the S&P 500 index shedding 5.7%.

Roller coaster week

“We’re looking at a year of big swings up and down. It’s going to be a roller coaster before we see a reversal. This isn’t stopping demand for structured notes. It probably is increasing it,” said a market participant.

A sellsider agreed.

“I think we’re going to see more selling. The market has welcomed inexperienced retail investors who have never known a bear market. For those, it’s trial by fire,” he said.

“My gut tells me we’re going to see more panic selling from retail. That’s what’s driving the drawdown. There are a lot of headlines around the Fed, around inflation, around Russia.”

The uncertainty associated with the Fed’s monetary tightening has fueled a sell-off in tech stocks ahead of Wednesday’s FOMC meeting.

“We haven’t seen days like Monday [Jan. 24] in a while where the Nasdaq drops 6% intraday. It’s wild. But it’s good for structured notes,” he said.

Indexes, autocalls

One of the immediate consequences of the sell-off may be a shift away from stock-picking at least for the moment.

“We’re seeing more indices,” he said.

“Income notes on indices, worst of three or four primary U.S. benchmarks whether that’s ETFs or indices, that seems to be the theme.”

“There are still many single stocks of course, but those are opportunistic, conviction plays.”

Autocallable notes continued to dominate. Eight percent of last week’s issuance volume came from notes with call features whether offered as Phoenix contingent coupon notes (70% of the total) or snowballs (10%), the data showed.

“The strong momentum to the downside in this start of the year has driven demand for more protection,” the sellsider said.

“The higher volatility leads to an overwhelming demand for income notes on indexes. The terms are now more attractive.”

“People are trying to protect their core exposure in their portfolios with products that can also drive some income.”

Cautiously optimistic

So far, sources are upbeat about the flows for this early part of the year.

“January is shaping out to be the best month with some of our partners. December was already a good month. But in just the first two weeks of the year, we’ve seen a lot of growth,” the market participant said.

“People are taking advantage of volatility, striking notes. It’s going to help.”

Inflows into structured notes may even help the overall stock market, he said.

“The banks have to hedge their positions. They’re long puts. This is going to offset some of the declines in the stock market,” he said.

“We’re at a point where the options market has more volume than the stock market. It’s the tail wagging the dog.

“Derivatives are controlling where the market is.”

This growing options volume originated from retail investors who have been buying options and also from the banks’ hedging activity, he added.

But the benefit of rising volatility on notes issuance works up to a point, he said.

The shorter, the better

“If the market takes a dive, the banks won’t have to hedge anything. You could see a pretty significant sell-off with the banks having to unwind their positions. It could cause all kinds of dislocations for the banks themselves,” he said.

Part of the “dislocation” comes from the “interconnectivity” between banks and hedge funds.

“If it’s a sharp, very short-term sell-off like March 2020, it’s not a big deal. It would be more of a problem if we had a gradual sell-off like what we had in the fourth quarter of 2018, which lasted three months,” he said.

For now, however, the higher volatility is a positive for structured notes issuance.

“Banks are offering attractive products right now. The Nasdaq is already down 13% this year. This will drive greater demand for defined outcomes,” said the sellsider.

Rotation in question

The choices of underlying stocks used last week did not reflect a specific pattern.

Notes linked to growth and tech stocks remained popular, but investors have cautiously moved toward value and small-caps. Yet the so-called “rotation trade” into value is not yet a clearly defined trend in structured notes sales.

“People have been talking about rotation from growth to value for years. It’s too soon to call,” the market participant.

Making short volatility bets while picking up the right stock or sector can be challenging in a fast-moving market, sources said.

Part of the mixed bag picture is that growth stocks and value stocks are impacted by a different set of risks, sources said.

For instance, rising rates have driven the tech sell-off.

But a harsh Fed’s reaction to inflation could threaten the economic recovery and weigh on cyclical stocks, explained the sellsider.

“Stock picks for deals are all over the place because buying decisions are very opportunistic. We see stocks in a variety of sectors. It’s not necessarily growth versus value,” he said.

Cars, banks, energy

Some of the most common names seen last week were carmakers, with Tesla, Inc., Ford Motor Co. and General Motors Co. leading the pack as autocallable underliers.

During the week prior to last week, Morgan Stanley Finance LLC priced a big Tesla deal for $30.7 million. The three-year notes pay a 15.85% annual contingent coupon with barrier levels set at 50%.

“We’re seeing a strong bid on carmakers because the commitment to electric vehicles is growing,” the sellsider said.

Energy stocks remained popular, with underliers such as Devon Energy Corp. and Exxon Mobil Corp. spotted last week. Energy, which was the top performing sector last year, fared better last week, shedding 3% versus 7% for technology.

“Energy stocks still reflect the inflation story line. We’re seeing those stocks as well,” the sellsider said.

Bank and cyclical stocks were used frequently too, such as for instance Boeing Co., Wynn Resorts, Ltd., JPMorgan Chase & Co. and Goldman Sachs Group, Inc.

“Anything cyclical in nature is in demand as the peak of Omicron is happening or has happened in most major parts of the world,” he said.

On the tech side, semiconductor company Nvidia Corp. remained one of the most common underliers.

GS Finance Corp. priced $12.34 million of 13-month autocalls on Nvidia with monthly coupon of 12.7% per year, barrier levels of 66% and a six-month no-call.

Investors continued to buy into pure tech plays, for instance Apple Inc. and Microsoft Corp.

In some cases, issuers assembled uncorrelated stocks to pump up the yield.

An example was UBS AG, London Branch’s $10.28 million of five-year autocallables linked to the least performing of Shopify Inc., Amazon.com, Inc., Nvidia and Tesla with a 25% contingent coupon, 60% coupon barrier and 50% downside threshold.

Indexes, growth

On the index side, the Russell 2000 index is increasingly seen in worst-of deals of U.S. indexes.

“The Russell has always been a popular index. But people may be doing more trades on it as they perceive value, cyclical small cap stocks as more insulated from the drawdown in tech,” said the sellsider.

Sources are also noting a pickup in growth products.

Leverage this year represents 17% of total issuance versus 11% last year.

“Advisors are reallocating portfolios right now. At the start of a year, people are looking at their books fresh. It makes sense to get into growth products, which are easy to allocate. Rising rates is a factor. But the timing is a bigger driver,” said the sellsider.

The top agent last week was UBS with $72 million in 38 deals, or 33.6% of the total. It was followed by Goldman Sachs and Citigroup.

GS Finance was the No. 1 issuer with $71 million issued in 14 offerings, a 33.2% share.

Issuance volume so far this year amounted to $2.05 billion in 509 deals through Friday. Those preliminary figures will be upgraded. The tally for the same period a year ago was $3.65 billion in 1,050 offerings.

© 2015 Prospect News.
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