Shortened week sees $220 million structured products price amid turbulent equity market

By Emma Trincal

New York, July 14 – Agents in the shortened week ahead of Independence Day priced $220 million in 106 deals, according to preliminary data compiled by Prospect News. Revised figures for the previous week, which was the last full week of the month, revealed a $1.35 billion tally in 328 deals.

This leaves the final two full weeks of June with abundant issuance volume: the updated tally for the week of June 20 was $2.17 billion.

Months, year to date

Overall, each month this year has surpassed the monthly volume recorded a year ago.

May and June especially have seen sales up by about 40% from the same month, a year ago.

The only exception was February which recorded a 4.6% decline from February 2020.

This year’s first-quarter issuance of nearly $23 billion is higher than the $20 billion posted during the first quarter of 2020, according to the preliminary data subject to significant upward revisions.

This year, marked by rising economic growth expectations and inflation, has been a good year for the sale of U.S. structured notes. Volume through July 9 is up 12.5% to $42.825 billion from $38.055 billion, the data showed.

The number of deals however is not growing as much: 11,754 this year versus 11,386 a year ago.

Back and forth

Equity markets were mixed last week with a Thursday stock sell-off leading the 10-year Treasury yield down to 1.25% while volatility briefly rose back to 20% as measured by the VIX index.

The yield plunge of 52 basis points since hitting a 1.77% high in March continued to puzzle market participants given that inflation can no longer be denied. But fears are arising about economic growth. The bond rally and stock sell-off may have been triggered by Japan’s decision to maintain a state of emergency during the Olympics, renewing concerns about the impact of the new Delta variant of Covid-19 on the global economic rebound.

On Friday however, the U.S. stock market bounced back, leading the S&P 500 index to its best-ever close.

Different signals

“This is not a boring market,” said Matt Rosenberg, director at Halo Investing.

“There’s a lot of activity in structured products because we don’t really see any definite trends. This is a market full of surprises.”

“People are a little bit puzzled. There are a variety of issues: the new Covid variant, inflation, a possible slowdown, the Fed’s next move, corporate earnings... There’s a lot of uncertainty out there.

“When people may have thought we would have a strong recovery, now they’re not so sure anymore.

“Looking at yesterday’s numbers, inflation is alive and well. But yields continue to be low on the long end of the curve. It’s very confusing.”

Consumer prices increased 5.4% in June from a year earlier, the biggest monthly gain since August 2008, according to a Labor Department report released on Tuesday.

Bond yields jumped on the news but were already lower on Wednesday.

Catch me if you can

For Steven Jon Kaplan, founder and portfolio manager at True Contrarian Investments, those divergences reveal a flight-to-quality ahead of an unavoidable stock market pullback. Since most of the downside protection offered by issuers are through barriers, structured notes are not necessarily as defensive as they would need to be, in his view.

“The U.S. stock market is at its highest level ever. If you look at cyclically adjusted price/earnings ratios, we have the highest multiples in history, higher than in 2000, 2008 or even 1929,” Kaplan said.

“People don’t look at how overpriced this market is. They think asset prices are going to keep on getting higher. They’re not seeing the biggest bubble in U.S. history.”

Many investors believe that as long as the Fed supports the equity markets by buying bonds and keeping interest rates near zero, market risk remains subdued, he added.

“People have too much confidence in the Fed,” he said.

“It’s as if you were on the edge of a cliff, relying on the person next to you to catch you. As more people get closer to the cliff and fall, with no one around to catch them, panic begins.”

Structured notes offer downside protection features, which is an advantage.

“But if you have a barrier, it’s only going to work if the market drops less than 15%, 20% or 30%. That’s not protection in my view,” he said.

Given current market valuations, Kaplan expects the market to drop in the 70% to 80% range.

Stretching yields

With a market trending up and yield going down, pricing conditions have not been ideal lately leading structurers to use yield-enhancement features.

“Issuer calls are one way to raise the coupon, for sure,” said Rosenberg.

In addition, investors tend to be neutral about the stated maturities of the autocalls they purchase. This has enabled issuers to shorten the tenors on autocalls, another way to extract premium.

“Put yourself in the shoes of those investors. For them, maturities are secondary. What counts is the likelihood of a call,” he said.

The average maturity of all the deals which priced last week was 22-months, according to the data. About 90% of the offerings had tenors comprised between 15 months and two years.

Shorter lengths

“People like to play 18 months or two years. There’s more risk on the short term so shorter-term notes will price better,” said Rosenberg.

For Kaplan, longer-dated notes would make more sense for those seeking protection.

“When you look at the probabilities of anything happening short-term, you get something close to 50/50. As you move further in time, you get more visibility. The pattern is less random, you can rely on seasonality and market cycles. You know that over time, there will be a massive reversion,” he said.

Thirst for yield

Lower yields may have a mixed impact on structured notes issuance.

“If yields continue to drop, it will increase the demand for autocalls as people are struggling to find yield. Not everybody wants to take higher credit risk with bonds. So, as we head into the summer, lower yields may help sales,” said Rosenberg.

“On the other hand, low yields are not great for pricing in general.”

S&P and Biotech

Not much changed last week in terms of underlying asset classes and structures.

Autocallables remained more dominant than usual, accounting for 90% of the volume. Equity indexes made for 57% of total sales while stocks continued to push forward accounting for more than a quarter of total volume. Exchange-traded funds rose to represent 17% of the total, in part due to two twin deals distributed by UBS.

Both issues consisted of five-year trigger callable notes linked to the least performing of the SPDR S&P 500 ETF Trust and the SPDR S&P Biotech ETF.

HSBC USA Inc. issued one of the deals for $25 million; JPMorgan Chase Financial Co. LLC priced the other for $11.41 million.

The first one pays a 7.89% contingent coupon with the two barriers at 70%, carrying a 2.25% fee. The second, which waived the fee, pays a 9.21% contingent coupon with identical barrier levels.

Energy premium

For stocks, some of the underliers seen last week on deals in excess of $1 million included Tesla, Inc., Snap Inc., L Brands, Inc., CrowdStrike Holdings, Inc., ViacomCBS Inc., Apple Inc., JetBlue Airways, Netflix, Inc. and Bank of America Corp.

Fewer energy stocks were used as the sector was battered last week due to concerns over a slower recovery, which along with other factors, pushed crude oil prices lower.

Some issuers however used the spike in volatility to price tactical plays, such as UBS AG, London Branch, which on Friday sold $1.03 million of two-year contingent absolute return autocallables linked to Diamondback Energy, Inc., a stock that dropped 10% on the week. The notes pay a 10% call premium. The issuer was able to drop the principal barrier at maturity to 49.5% with a 50.5% range of absolute return above that strike.

UBS also issued a $1.6 million autocallable deal on Apache Corp., another energy stock down 7.7% on the week.

Top deal

The top deal last week combined two yield-enhancement features: the discretionary call and a daily observation barrier for the coupon.

“I don’t love American barriers even if it’s only on the coupon. It adds too much uncertainty,” said Rosenberg.

Barclays Bank plc priced $49.6 million of trigger callable contingent yield notes with daily coupon observation due Jan. 11, 2024 linked to the worst performing of the MSCI Emerging Markets index, the Russell 2000 index and the S&P 500 index. The notes pay 8% a year as a quarterly contingent coupon on a 70% coupon barrier observed daily. The issuer can call the notes on any quarterly payment date. The barrier at maturity is 60%. UBS Financial Services Inc is the agent.

While Rosenberg said American barriers can be a tough sale, their inclusion in a product is a source of additional premium.

Compared to a hypothetical autocallable structure with no daily observation coupon, he said that the two features may have enhanced the coupon by 2.5% to 3%.

“My guess is that the issuer call adds about 100 basis points and the American barrier, probably between 150 and 200 bps,” he said.

“The added value is significant.”

Last week’s top agent was UBS.

The No. 1 issuer was Barclays Bank plc.

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