Structured products issuance $758 million for week, helped by BofA’s monthly pricing

By Emma Trincal

New York, Nov. 2 – Structured products agents sold $758 million in 91 deals last week with BofA Securities capturing 57% of the total via $435 million sold in 27 offerings, according to preliminary data compiled by Prospect News. This agent always prices the bulk of its monthly calendar at the end of each month.

Most of BofA’s top deals were leveraged notes issued by Canadian banks. It has been typical for BofA to diversify its platform with Canadian credit. But for a while this agent had turned more to U.S. issuers for its block trades than before. Only recently has the Canadian paper regained its former prevailing place within BofA’s open architecture.

Canadian issuers last week brought to market two-thirds of total notional in only 43 offerings.

Creditworthiness

“Canadian banks are considered stronger credit than the U.S. banks. You saw less of them a couple of years ago because rates were so low. The funding gap between Canadian and U.S. issuers is now much closer. They can price at levels that are very competitive with U.S. banks,” a sellsider said.

A structurer said that advisers seek Canadian names more for diversification purposes than because of those banks ‘perceived creditworthiness.’

“Investors don’t care that much about relative credit strength. Unless there is something that’s always in the news like Credit Suisse, they don’t pay that much attention to credit risk exposure. It’s not like they’re comparing credit spreads between banks,” he said.

On the other hand, banks’ funding needs and strategy to penetrate the U.S. market play a relatively more important role, he added.

Funding factor

“Canadian issuers are competing with U.S. banks. I’m sure the terms on their notes are just as good as what U.S. issuers provide,” this structurer said.

The demand from advisers indirectly derives from the treasury operations of the issuer, he explained.

“If the treasury of the bank needs funding, they will give the structuring desk higher rates to play with, which is more money for them to spend on the options. Usually, the way it works is the structuring desk will come to the treasury and say: I have $10 million, how much can you pay me for it?”

It has worked well for Royal Bank of Canada, Canadian Imperial Bank of Commerce, Toronto Dominion Bank and Bank of Montreal, which have all seen a positive growth in issuance volume year to date. CIBC topped the group with an increase in volume of a third.

Top deals

Royal Bank of Canada issued last week’s top deal with $73.77 million of two-year leveraged notes linked to the S&P 500 index. The payout is 2x the upside up to a 28.01% cap. The downside is buffered by up to 10%.

BofA Securities, Inc. is the agent.

Canadian Imperial Bank of Commerce priced the second deal for $52.08 million also from via BofA’s distribution channel. The 14-month leveraged note on the S&P 500 index offers triple any index gain, capped at par plus 23.55%. Investors are exposed to any index decline.

Separately, JPMorgan priced on the behalf of GS Finance Corp. $36.87 million of 13-month digital notes linked to the S&P 500 index. If the index finishes at or above its threshold level, 85% of initial level, the payout at maturity will be par plus 11.65%. Otherwise, investors will lose 1.1765% for every 1% that the index declines below 15%.

Leverage

There was plenty of leverage last week – 49% of total notional. While leverage has regained traction, its penetration rate is much more modest during other weeks of the month in the absence of BofA.

This agent indeed specializes in “Accelerated Return Notes,” or short-term leveraged structures on the S&P 500 index, with or without buffer. For the year to date, income products (autocalls or callable notes) are still the main structure with 43% of the total versus 24% for leverage.

“People will still continue to use income notes in this volatile market because leverage is not as volatility-sensitive as contingent coupons are,” said the sellsider.

“Whereas you were only getting a 7% to 8% coupon a few months ago, now you can have north of 10%. Obviously, it’s a big change.”

Leverage’s survival kit

Increased volatility does not significantly improve the terms of leveraged products, he said.

“Leverage has been hampered by the lower dividend yields of the S&P compared to three or four years ago. When you have a 4% dividend to hedge the S&P, you’re in a better position than you only have 2%.

“Rising interest rates has mitigated some of that problem though,” he said.

Another mitigating factor has been the growth of so-called decrement indexes where the issuer sets the dividend yield as a fixed, synthetic yield.

“It’s much easier to hedge,” he said.

The risk for investors is to underperform the index if the decrement dividend yield is set too high.

“Overall, the market is still pretty much dominated by contingent coupon notes and will continue to be for some time,” he said.

Big tech under pressure

Equity indexes accounted for more than 85% of total issuance volume, last week.

The week was volatile with a heavy sell-off in mega-cap tech stocks such as Microsoft, Alphabet and Meta Platforms, which all fell sharply after missing earnings estimates.

But the sector recouped by Friday in part due to Apple’s strong performance. The S&P 500 index finished the week up 4% and the Nasdaq rose 2.2%.

Sharp losses among tech giants do impact broader indexes, noted Steve Sosnick, chief strategist at Interactive Brokers. The market capitalization of the Nasdaq-100 index’s largest components is highly concentrated with the top seven companies making up about 40% of its weight, he noted.

The S&P 500 index is also heavily weighted in tech stocks with only five names – Apple, Microsoft, Amazon.com, Tesla and Alphabet – accounting for 20% of the index weight.

In theory, one solution to limit the tech bias would be for investors to use equally weighted underlying indexes, noted the structurer. But in practice, those indexes have not been popular and for good reasons, he said.

“Equally weighted indexes are not going to gain traction any time soon. It’s like a contrarian approach. You’re basically saying: the market price is wrong. But prices are never wrong. People who want to buy the whole U.S. market are looking for momentum and growth, not for equal weights,” he said.

Stocks, ETFs

Equity underliers excluding indexes (single stocks, baskets of stocks and ETFs) represented only 14% of total sales, less than the year-to-date average of 21%. Single-stock underliers were particularly underrepresented with less than 4% of the total versus 13% on a yearly basis. Obviously, investors’ attention was not on earnings, said the structurer.

“There was a flurry of earnings last week, but retail investors prefer getting exposure to the whole market especially when the market is so volatile. People who buy structured notes usually don’t watch the earnings. They don’t play that kind of game. Those who do tend to buy the stocks directly.”

PPNs

Principal-protected notes are reemerging in the market including bullet notes with relatively short maturities.

As an example, HSBC USA Inc. on Monday priced $929,000 of 18-month notes on the S&P 500 index with a 100% participation rate on the upside capped at 12.20% and full principal-protection on the downside.

“Wider funding rates explain how usually more costly structures can now be priced more easily. All structured products do better when rising rates are higher,” the structurer said.

Year-to-date volume

Agents sold $71.15 billion in 16,312 deals this year through Oct. 28 versus $81.61 billion in 24,609 deals in the year-ago period, a 12.8% decrease, according to the preliminary data.

“We’re down by approximately $10 billion. That’s not necessarily a lot,” the structurer said.

“In percentage terms, 12.8% is much less than the decline we had earlier this year, which if I recall was more like 20%. “Also, we’re comparing this year with 2021 but it’s not a fair comparison. 2021 was a stellar year.”

Issuers last year priced $100.3 billion, a 38% jump from 2020, according to data compiled by Prospect News. The year 2021 was the best on record since Prospect News began collecting data in 2004.

“We’re making up a little of the lost ground. It’s pretty certain that volume will end up down this year since we don’t have much time left, but we may see the gap narrow even more, perhaps by less than 10%,” the structurer said.

This year’s market conditions were in large part to blame for the decline, the sellsider said.

“I bet if you look at new money going to work, we’re up from last year. But a lot of the deals done in January, February or March this year are not getting called after the typical six-month no-call. A lot of the recycling volume is just not there. We have a slower velocity of money. That’s why volume is down.”

The top agent last week after BofA was UBS followed by JPMorgan.

Royal Bank of Canada was the No. 1 issuer with $159 million in 17 deals, or 20.9% of the volume.

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