Structured products weekly tally at $794 million; yearly sales down 20% amid correction, war

By Emma Trincal

New York, March 16 – Structured products agents priced $794 million in 158 deals last week, according to preliminary data compiled by Prospect News, as volatility in the market continued to jump, pushed up by oil prices hitting $130 a barrel, the war in Ukraine and soaring inflation, which raised concerns about a recession. Investors were also waiting for the Federal Reserve to hike rates on March 16.

The Nasdaq-100 index fell into bear market territory, down 3.5% for the week. The Dow Jones industrial average fell 2% and the S&P 500 index was down 2.9%.

Down year

For the structured notes industry, the real bad news was the decline in issuance volume for the year to date.

The tally this year through March 11 is $15.20 billion in 3,044 deals versus $18.99 billion in 5,679 offerings last year, a staggering 20% decline in volume, the preliminary data showed. While figures remain preliminary and will be revised upward, the gap is already wide over only two-and-a-half months.

“It doesn’t surprise me,” a bond trader said.

“The stock market is down. The S&P is down. The Dow is down.”

The main factor behind the stock market sell-off was valuations, he said, not the geopolitical crisis.

“Valuation did not keep up with stock prices. Earnings have not kept up because they are affected by the economy. The stock market has to catch up with high price/earnings ratios.”

Pullback

For this trader, the stock market is directly and negatively impacting the sales of products.

“Nearly 90% of structured notes issuance is equity-linked. The market rallied in 2021, and we had a record year. It’s down this year so now equity products are suffering. There’s an obvious correlation no matter what people say about buying the dip and jumping in when volatility makes the terms look better,” he said.

“People are just less interested in investing. They’re also getting a sense that we’re heading toward a recession.”

While Ukraine has increased bearish sentiment among investors, the sell-off existed before the invasion on Feb. 24, he said.

Fed behind the curve

“Most people are still unsure about what the Fed is doing. We know they’re expected to hike rates 25 basis points today. But back in November they also announced they would start tapering. More than four months later they still haven’t done any tapering,” he said.

“In the meantime, the bond market has responded. Interest rates have spiked dramatically.

“Bond traders watch the economy. The bond market will always tell you what’s going to happen. The stock market only tells you what’s happening.”

Interest rates have “spiked” dramatically, he said, especially on the front-end of the yield curve.

“The two-year Treasury yield is up more than 100 bps since the beginning of the year. The Fed’s 25 bps increase doesn’t even move the needle,” he said.

Economic picture

One main factor behind the stock market turmoil is the increasing perception that the economy could fall into a recession, he said.

This bond trader looked at the 10-year Constant Maturity Swap rate minus the two-year CMS rate, which he said is the best forecaster of an upcoming recession.

“Once that spread between the 10- and the two-year is inverted it’s the canary in the coal mine. You get a recession within one year to 18 months,” he said.

The spread went from 70 bps at the start of the year to 18 bps today, he noted.

“We’re not inverted yet but we’re getting there. This curve is flattening, which tells us we’re heading toward a recession,” he said.

He pointed to “weaker-than-expected” retail sales figures released on Wednesday morning.

“The huge spike in gas prices isn’t leaving enough discretionary income for consumers to spend,” he said.

“The economy is on the weaker side. This inflation is a big deal. More people are concerned about stagflation at this point.”

New versus old money

A more mechanical explanation often advanced to explain the weaker issuance volume this year is simply that notes are not called.

“It’s a logical explanation but I would be curious to know what’s the percentage of deals that are done on reinvested money versus those done with new cash. If it’s true that the overwhelming majority of new issues come from call proceeds and not new money, then yes, the argument is valid. But I don’t have the answer to that,” he said.

Sweet spot tenor

Many market participants anticipate the Ukraine-Russia crisis to be resolved relatively shortly, which may have an impact on the length of the deals.

“This war is affecting everything,” the bond trader said.

It may impact the tenors as well.

The average duration of notes last week was two years.

“The real concern is short term,” one market participant said.

“I don’t think what’s happening in Ukraine is a long duration event. The situation for them is unbearable. We’re going to see a resolution one way or the other. We still have challenges. We still have supply issues and inflation issues. But at some point, we will be hitting new market highs.

“Either the conflict escalates to the ultimate point, a nuclear Armageddon and we don’t have to worry about it. The world would be over. Or the situation gets resolved, and if it does, it should be within a couple of years.

“Our sweet spot is between 24 and 30 months.

“It’s not too long. And that gives the market enough time to rebound.”

Indexes, leverage

Last week continued to see a push toward safety with more pricing on broad-based indexes.

Equity-index notes made for 74% of the total issuance volume versus 15% for ETFs and 7% for stocks (single names and baskets).

Callable notes (49% of last week’s notional) continued to prevail, but leveraged plays gained market share (31% of the total). The proportion of callable products is in line with the average of 50% year to date through March 11 while leverage was higher than the average penetration rate seen this year at 25%.

More telling is the proportion of callable products versus leverage during the same time last year – 67% and 17%, respectively.

The rise of leveraged products is concomitant with the decline of income-generating notes with call features.

Two big leveraged trades

The two largest offerings last week provided short-term capped leveraged exposure on the upside with no downside protection.

The first one was UBS AG, London Branch’s $83.44 million of 13-month notes linked to the S&P 500 index.

The payout at maturity will be par plus 1.25 times the gain, capped at 26.25%.

UBS Securities LLC is the agent.

Next, Goldman Sachs priced on the behalf of Bank of Nova Scotia $56.56 million of notes tied to the Russell 2000 index with 1.25x leverage up to a 33.37 maximum payout.

“These are risky bets. No downside protection. A year from now, the economy could be headed the other way,” the bond trader said.

“But they’re popular because a lot of people are leveraging against a long position.

“If you have $100,000 to invest in one of those notes, you only have to put $80,000. If it’s up, good. If it’s down, you’re not putting your entire investment at risk.

“The greater the leverage, the better. When you have three times up, you can just put a third of your notional to work.”

Callable, American barrier

On the income product side, Morgan Stanley Finance LLC sold $42.63 million of trigger callable contingent yield notes with daily coupon observation due June 12, 2025 linked to the least performing of the Dow Jones industrial average, the Russell 2000 index and the Nasdaq-100 index.

The notes will pay a contingent quarterly coupon at 13.28% per year if each index closes at or above its coupon barrier level, 70% of its initial level, on every day for that period.

The notes will be callable at par quarterly.

The 55% barrier at maturity is observed point to point.

The top agent last week was UBS with $291 million in 76 deals, or 36.7% of the total. It was followed by Goldman Sachs and Morgan Stanley.

The No. 1 issuer was UBS AG, London Branch, which brought to market 71 offerings totaling$173 million, a 21.7% share.

© 2015 Prospect News.
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