January sales of structured notes hit more than $9 billion, the fifth best month in 20 years

By Emma Trincal

New York, Feb. 14 – A bull market and crushed volatility levels have apparently not hampered an outpouring flow of structured notes if one looks at the tally for January, the fifth best month in history, going back to 2004.

Issuers priced $9.19 billion last month in 1,851 deals, according to preliminary data compiled by Prospect News.

These figures will be revised upward as more deals will be added to the tally.

The best month was September 2022 with $11.03 billion in 3,035 deals. March of last year and March 2022 took the second and third places, respectively. November 2021 ranked fourth.

A lot of money

“A few weeks ago, I already knew that January would be huge. I’m not surprised at all,” said Brady Beals, director, sales and product origination at Luma Financial Technologies.

“It’s a combination of a lot of money that hasn’t been deployed because vol. is too low. At some point, advisers need to move on. You can’t sit and wait for volatility to come.”

Reinvestments of call proceeds were another determining factor.

“You also have a lot of notes getting called with the market so high. Many deals, which priced in the beginning of 2021, are starting to mature. These are three-year notes, a very common tenor.

“There’s just a lot more to invest,” he said.

Beals was optimistic for the current month as well.

“February looks very strong too. I’m guessing that it’s going to be even better than January,” he said.

The wrong direction

For Mark Dueholm, chief fixed-income trader at Landolt Securities, investors and advisers are buying a lot more notes at the wrong time.

“People are optimistic because last year was such a good year. Who would have thought that the S&P would be up so much following such a terrible year?” he said.

The S&P 500 index rose 24% last year after losing nearly 20% in 2022.

“But that kind of optimism is probably not the best way to go,” he said.

For Dueholm, bull markets are not the best environment for alternative investments such as structured notes.

“I love structured products when the market is down. With volatility spiking you get higher coupons and lower entry prices. Right now, it’s the opposite. The terms aren’t so good. Investors are buying high, increasing their risk.

“People don’t think the right way,” he said.

He concluded that bulls’ buoyancy contributed to last month’s high issuance volume.

“It’s totally sentiment-driven,” he said.

Heavy bid on ETFs

Issuers last week priced 100 deals totaling $590 million. While preliminary, this figure already reflects a vibrant market for the first week of the month.

One notable point was the high proportion of ETF underliers.

This asset class totaling $101 million accounted for 17% of the week’s tally, a larger-than-average market share compared to 8% this year and 12% a year ago. Most of those ETFs were sector specific.

“When volatility drops people turn to sector bets. They’re looking for yield,” said Beals.

Dueholm agreed.

“You get a lot more yield when you play different sectors because it’s riskier. People are convinced there’s going to be a soft landing.

“If the market becomes choppier, you’ll see fewer ETFs and more broad-based indices,” he said.

Single, not single

About 60% of these notes consisted of single ETF underliers while the remaining 40% involved worst-of.

Issuers used a variety of ETFs such as the SPDR S&P Metals & Mining ETF; the SPDR S&P Biotech ETF; the VanEck Oil Services ETF; the VanEck Junior Gold Miners ETF; and the SPDR S&P Regional Banking ETF.

Broad-based market ETFs were seen in only two deals: the iShares Russell 2000 ETF; and the Invesco QQQ Trust, Series 1.

Bank of Nova Scotia priced the top single-ETF deal in $21.13 million of 13-month digitals tied to the SPDR S&P Metals & Mining ETF. The product, which showed an 85% strike, 15% geared buffer and 10.74% payout, was the largest single ETF deal.

The top worst-of ETF was brought to market by UBS AG, London Branch in $22.05 million of callable notes linked to the iShares Russell 1000 Growth ETF, the iShares Russell 2000 ETF and the Utilities Select Sector SPDR fund with a 10.75% contingent coupon.

Macro bets

Aside from yield search, the motivation behind the purchase of ETF-linked notes may not be so different from buying a fund outright.

“People are expressing a view,” said Beals.

“Bets on oil for instance usually come from the view that inflation may be a little bit hotter than expected and that the economy is getting stronger.”

Deals tied to energy, either indirectly through equity energy ETFs or through oil futures prices, amounted to $50.2 million in seven deals, an 8.5% share.

Rates up, hopes down

Higher interest rates should help pricing, but it depends on how much and how long the trend lasts as well as the structures being built.

“Rates this year have gone up a lot. It’s a good thing. But ultimately, volatility is the key driver behind better coupons, better terms in general,” said Dueholm.

Rates were up for most of 2023, peaking around mid-October but then reversed course and dropped for the rest of the year. This year, yields have moved higher. Both the two-year and 10-year rates have jumped more than 40 basis points so far.

“Rates are up again. That’s because for a while the Fed talked and the market didn’t listen. People kept on expecting rate cuts even though the Fed did not give them any indication that they would,” he said.

“Now the market finally realized that the Fed was right. Inflation is still too high and the economy too strong for the Fed to cut anytime soon.”

Indexes

Equity indexes last week accounted for 61% of the week’s notional, slightly less than the two-thirds share seen so far this year. A total of $362 million of index-linked notional was sold in 49 offerings.

Out of this amount, $183 million priced in the worst-of format while $179 million were notes tied to a single index. The breakdown between the two category was fairly balanced, which is not always the case.

As always most of those index-linked notes were autocalls.

Total issuance of callable notes, including autocalls, issuer calls and snowballs, was $432 million in 70 deals, a 73% share of the week’s total.

Eggs in one basket

Over the past few weeks or even months, the Nasdaq-100 index has rarely been used as a single underlier, according to the data. Instead, issuers have employed the tech-heavy benchmark primarily in worst-of. Last week for instance, none of the 15 offerings including the Nasdaq-100 was priced with the benchmark used as a sole underlier.

In contrast, the Russell 2000 index, a frequent worst-of component, was also employed as single asset in several deals.

“The Russell has underperformed for a long time and people avoided it a lot. Now with the economy stronger, they feel more comfortable using it as a stand-alone underlier,” said Beals.

“They’re more nervous about the Nasdaq. It was up 43% last year. How much more upside can you get?

“So, they’ll use it in worst-of.”

Beals said such reasoning was odd.

“When you think about it, if the Nasdaq is going to sell off and drop more than other benchmarks, because it’s already so high, you still have exposure to it.

“Investors get complacent with worst-of. They see a worst-of as diversified basket while it’s not.

“You’ll get more coupon with a worst-of. But it’s essentially the same kind of risk,” he said.

Last week’s top deal was Barclays Bank plc’s $54.3 million of three-and-a-half year callable notes on the worst performing of the Nasdaq-100 index, the Russell 2000 index and the S&P 500 index.

The notes, which are callable quarterly, pay a contingent quarterly coupon of 10.65% per year based on a 70% American barrier, which means that the price is monitored daily. The barrier at maturity is 60%. UBS is the agent.

Last week’s top agent was BofA Securities with $160 million sold in 20 deals, or 27.2% of the total.

It was followed by UBS and JPMorgan.

JPMorgan Chase Financial Co. LLC was the No. 1 issuer, bringing to market $78 million in 17 offerings, a 13.2% share.

© 2015 Prospect News.
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