Structured products Q4 issuance may lag despite being best quarter of year for stocks

By Emma Trincal

New York, Jan. 10 – Structured products agents priced $21 billion in 4,510 deals in the fourth quarter, slightly behind the top quarters of Q1 and Q3, which recorded $25 billion each, according to preliminary data compiled by Prospect News. The third quarter posted $23 billion in 5,675 offerings.

The first quarter had the greatest deal count with 7,409 deals. The fourth quarter only recorded 4,510 deals.

It may be too soon to conclude that Q4 was the weakest quarter, however. These figures are preliminary and will be revised upward due to the lags between pricing and filing dates, which worsen during holiday periods, especially at year-end.

Strong rebound

The market rallied for nine consecutive weeks in the last three months of the year, pushing the S&P 500 index up 11%, making the fourth quarter the best of the year for stocks. This early and vigorous “Christmas” rally more than offset the losses seen from the beginning of August to the end of October.

Despite a regional banking crisis in March and geopolitical tensions in Europe and the Middle East, all the main benchmarks were up last year.

The main drivers were an AI craze propelling the Nasdaq 43% higher for the year, its best performance in two decades. Persistent expectations of future rate cuts from the Federal Reserve were another driver.

“With a sideways and bearish market in the past couple of years, bullish bets started to pick up last year, especially on the view that the Fed would start cutting rates and that inflation was coming down,” said a distributor.

“The idea that the economy may be on soft-landing mode was also a factor, which played out especially in the last couple of months of the year.”

Higher rates

“For us, it was a pretty strong quarter. December was the best month of many years,” a sellsider said.

The unforeseen pace or rising interest rates allowed issuers to structure more compelling products, especially those based on zero-coupon bonds.

The 10‐year Treasury note yield began the year at 3.9% and jumped slightly above 5% in October.

“We’ve seen a strong pickup in principal-protected notes and market-linked CDs as a result of higher rates,” this sellsider said.

“It’s not just the market. I think a lot of advisers are increasingly comfortable with structured products. People are getting creative in pairing up different assets to add some protection and generate attractive returns,” he said.

“Advisers have gained more expertise in building the products that they want.”

The relationship between an upward-trending stock market and increased issuance volume of structured notes is hard to pin down, a bond trader said.

“It’s very situational. It depends a lot on the investment style. Some people are watching underperforming sectors to strike a note. Others are driven by momentum and will be looking at tech stocks or indices no matter how highly valued they are because they keep on moving up.

“Overall, I think the most important thing people look at is the yield.”

Yields trending down

The uncertainty remains about the direction of interest rates. After hitting 5% on Oct. 20, the 10-year Treasury yield fell down to 3.8% at the end of the year. Rates have resumed their upside trend since but at 4%, the 10-year yield remains far from its 5% high.

A bond trader saw the downtrend continuing this year.

“The bond market is pricing lower rates, and the bond market is the best at reading the tea leaves. When bond traders see rates coming down, what they’re saying is that we’re in a recession,” he said.

“The yield curve is still inverted. Let’s just say it’s less negative than it was but it’s not positive.”

For this trader, the talk about decreasing inflation levels is just “noise.”

“Inflation coming down from a high doesn’t mean it’s under control,” he said.

A “sticky inflation” may be what would trigger a recession or worsen it, he noted.

“Consumer prices have gone up between 15% and 20% in the last three years. Now they may be going up less, but they’re higher than they were. Real wages are only up slightly. Bottom line: there is less discretionary income. People are hesitant to buy and when they do buy, they use their credit cards. It’s not sustainable,” he said.

If the Fed cuts interest rates as the market expects, it may not be due to a win in the battle against inflation, he argued.

“The Fed has no choice but to follow the market. There was a time when the market followed the Fed. Now it’s the other way around,” he said.

“After they raised rates 525 basis points, the economy can’t sustain higher rates. Try to do it and see what happens.”

Flexible marketplace

The impact of lower rates may have positive ramifications for structured notes issuance, he said.

“It would be a big boost for the stock market,” he said.

“The main theme would be again: income.”

He said he was confident about the marketplace’s ability to generate yields even in less favorable conditions.

“You may see different terms. You could get into a 70% barrier instead of a 65% to maintain the same coupons that we have now.

“People may be looking for yield in some particular areas,” he said.

He said that AI stocks such as the “Magnificent Seven” should still be in favor despite their high price-per-earnings ratios.

“Tech has been a big deal. More tech companies are getting involved in AI. Some analysts are talking about a rotation out of AI but I don’t see that,” he said.

“What’s more likely is that people will watch volatility more closely. A sudden drop in one of those high-growth stocks could be a catalyst. It would be situational. I also see a move toward income-producing assets, like utilities.”

Top Q4 deals

The fourth quarter saw the pricing of several equity-linked block trades in excess of $100 million.

Morgan Stanley Finance LLC in mid-December priced $125 million of 8.77% one-year callable fixed-income securities, whose return is linked to the worst performing of the Russell 2000 index, the Nasdaq-100 index and the S&P 500 index. Interest will be payable monthly. The notes will be callable at par plus the coupon on any monthly observation date after six months. The principal repayment barrier at maturity is 70%.

Second, Bank of Nova Scotia priced at the end of November $112.57 million of 14-month notes on the S&P 500 index. The payout at maturity is triple any index gain, up to a maximum return of par plus 13.95%. Investors will be exposed to any index decline.

Morgan Stanley issued a $104.46 million deal of cash-settled equity-linked notes on the share price of RTX Corp. in early November. The notes, which are considered as a hybrid, are synthetic convertibles.

Royal Bank of Canada priced three-year digital notes on the S&P 500 index for $103.96 million in early October.

$500 million offering

But much bigger trades came out earlier in the year.

In September, GS Finance Corp. brought to market the biggest deal of the year with $500 million of three-year fixed-rate equity-linked notes linked to the stock price of Palo Alto Networks, Inc.

During the preceding month, Barclays Bank plc issued $490 million of three-year notes tied to Alphabet Inc.

In both cases, those hybrid products were synthetic convertibles.

Down the list several fixed-to-floating rate notes were priced ranging from $381.8 million to $131.5 million and linked to the one-year or two-year U.S. dollar SOFR ICE swap rate.

The top agent for Q4 was Morgan Stanley with $4.30 billion sold in 666 deals, a 20.5% share.

Preliminary figures for last year’s totals showed $93.87 billion issued in 22,995 deals, a 1.6% decline from the $95.36 billion sold in the previous year in 29,628 offerings. These numbers will be revised upward.

The best months in 2023 were March with $9.6 billion, August with $8.98 billion and February with $8.47 billion.

March 2023 was the best month in 20 years after September 2022, which posted $11 billion in sales, according to the data.

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