Structured notes see 26% of issuance tally come from stock underliers this year

By Emma Trincal

New York, March 20 – Structured products issuance volume is up 13% to $21.44 billion for the year to date through March 15 from $18.98 billion for the comparable period last year, according to preliminary data compiled by Prospect News.

February’s tally is on par to equal and probably surpass January’s based on the preliminary data showing sales at $9.14 billion and $9.95 billion, respectively. Data for last month is still expected to be revised upward.

Complete data for last week was not available. But the first week of March was exceptionally strong for the beginning of a month, showing $1.92 billion in 306 deals.

During that week Citigroup Global Markets Holdings Inc. priced $117.59 million of 15-month leveraged notes on the S&P 500 index paying 300% any index gains capped at 16.35% with no downside protection.

Several factors contributed to this year’s growth. First the equity bull market has triggered early redemptions for callable notes, which make for 53% of total issuance this year.

Explosive growth

A second driver has been the exceptional volume growth of stock-linked notes issuance this year. The tally for single stocks is nearly $5 billion and baskets of stocks represent $565 million. Overall, the asset class makes for about $5.5 billion, or 26% of total sales. Last year, the stock tally was $2.1 billion, or 11% of the total. In dollar amount, volume in this asset class has surged by 162%.

“Volatility in the indices is just not there. The premium over Treasury is at the lowest it’s been for years. So, people are moving into stocks,” said Brady Beals, director, sales and product origination at Luma Financial Technologies.

Two big convertibles

Part of the growth is due to the sales of a few stock-linked jumbo offerings this year. Those notes fit the definition of equity derivatives given the underlier, but their structure is more akin to a convertible bond.

The most recent one was Citigroup’s $417.45 million of equity-linked notes on Nvidia Corp. earlier this month. Barclays Bank plc did another synthetic convertible deal in the beginning of February with $794.12 million linked to Microsoft Corp.

“The people who do those kinds of sizes are a different type of investor. They specialize in traditional convertible bonds, fixed-income. They will venture out in the structured note market to do some convertible-like issue. This is not the run-of-the-mill of the RIAs,” said Beals.

Mag7 as underliers

Stock-linked issuance has also jumped this year as a result of the overall equity bull market powered by AI.

The “Magnificent Seven” (Apple, Microsoft, Nvidia, Alphabet, Meta, Amazon and Tesla) have accounted for 44% of the S&P 500 index return this year with Nvidia alone responsible for 19.9% of the benchmark’s return, according to Michael Mullaney, director of global markets research at Boston Partners.

Naturally the AI craze has impacted the structured notes space. Twelve percent of total issuance this year is linked to one of the seven “Magnificent, according to data compiled by Prospect News. This market share only accounts for single stocks at the exclusion of worst-of or weighted basket.

“We see tons of Mag7 notes,” a sellsider said.

“It’s not surprising. Notes are a retail product, and retail tend to buy what’s hot.

“These are stocks that by their nature have a lot of volatility, which is attractive in a market where volatility has hardly picked up.

“Put those two factors together – hot and volatile – and it makes sense.”

Safety move

Some investors appreciate the advantages of a structured note versus a long only position, he said.

“I wouldn’t buy those high-flyers at this point. The contrarian in me would be more cautious,” he said.

“But at the same time, if you really want exposure to these Mag7, it’s a good idea to use a note. As long as you’re willing to give up a little bit of yield for some protection, you’re probably better off than buying the stock outright.”

High-flyer

AI leader Nvidia, which jumped 80% this year, has led the charge among the group making for 3% of the year-to-date issuance volume.

“There’s always a stock of choice. During Covid it was Moderna and Peloton. Then you had Tesla forever. Now the appetite has shifted to Nvidia. The tech sector overall is still the big driver,” said Beals.

In January 2023, Nvidia was at $200. Now its price is near $900.

“It’s insane. In 15 months, it has more than quadrupled. If you don’t take any profit, you are a fool,” the sellsider said.

Semiconductors

Other AI stocks, which are not “Magnificent” are also highly popular among structured notes investors.

Unlike Microsoft and Nvidia, which have been used in block convertible trades, those are the day-to-day supply of the market.

Advanced Micro Devices, Inc., which hit $164 million in sales, is the most popular one. The stock is highly volatile and expensive with a price-per-earnings ratio of 346.

The demand for semiconductors underlying stocks is very selective. Some names are widely used but to a lesser degree than Mag7 plays. Those include Qualcomm Inc., Intel Corp. and Micron Technology Inc.

Other popular semiconductors in the stock market, such as Microchip Technology Inc., KLA Corp., LAM Research Corp., Texas Instrument Inc. and Analog Devices Inc., are virtually absent from the market this year.

A word of caution

Analysts are beginning to see some cracks in the AI euphoria, which could impact market sentiment and choices of structured note buyers.

For one thing, investors are realizing that inflation may not be declining as quickly as expected, which reduces the chances of aggressive rate cuts.

AI stocks have been the big story this year not just in the equity market but in the structured notes space too, said Beals.

“But people get the sense that those stocks went too far. The concentration of the top 10 stocks in the S&P is the highest since 1929.”

Some big AI names were under selling pressure last week. Tesla plummeted by 6.7% after the release of a negative report from a UBS analyst. Adobe fell by more than 13% after missing earnings expectations on Thursday.

The Invesco PHLX Semiconductor ETF dropped 4% on the week.

Moreover, three of the “Seven” are down this year. Tesla has fallen by 30% and Meta is down 42%. Apple is slowly recovering but still eased 8%.

“I think it’s pretty healthy. These are probably institutional investors taking a profit. No matter how bullish you are, when you have such huge gains at some point you have to sell your position or at least a portion of it,” the sellsider said.

Possible rotation

Some buyers of structured notes are showing more caution.

“I noticed clients tend to move away from Nasdaq,” said Beals.

“The S&P 500 Equal-Weight index was gone for a while but it’s back again.

“Last year, people were not so concerned about a big correction. But now they see a bigger risk.

“It doesn’t mean Mag7 deals are not getting done. They are. But we may be up to some kind of sector rotation although it’s unclear.”

Despite its strong performance the energy sector does not appeal to his clients, he said.

“Energy has become boring. Oil prices are stuck in a $70-$90 range,” he said.

“We see some financials. But there is a concern about regional banks and in the uncertain rate environment, the appetite for this sector is limited.”

He noticed however more demand for underliers in the consumer discretionary sector, citing stocks such as Disney, Amazon and Nike.

“We’re observing a slight bias toward more conservative names,” he said.

Memorizer: the next new thing

On the innovation front, Citigroup this month came out with a new structure in $2.66 million of autocallables linked to the worst of Adobe Inc., Advanced Micro Devices, Inc. and Netflix, Inc.

The notes will be automatically called monthly if the three stocks close at or above 85% of their initial price. But each stock can meet the threshold condition on any monthly observation date, one after the other and not necessarily simultaneously. Once all three stocks have met the condition at least once, the notes will get called. The barrier at maturity is 60%. The call premium is 23% per annum.

“Yes, I’ve seen this before. It was invented by Banco Bilbao Vizcaya Argentaria. All the stocks have to be above the barrier but not necessarily at the same time. It reduces your risk and therefore your coupon is lower,” said Beals.

He said he priced one of those “memorizers” and compared it with a traditional autocall.

The regular autocall had a 12.25% coupon and the memorizer priced at 12%.

“It was only a 25-bps difference. Why? Because even though the memorizer gives you a slightly higher chance to be called, it’s not a hugely higher chance. It decreases your risk but not in a significant way. That’s why you don’t see a huge decrease in the coupon,” he said.

Asked if he believed that memorizers may gain traction as a new product, his response was negative.

“I don’t think you’ll see a lot of them. If you compare them to memory coupons, another interesting feature...a memory coupon has a huge impact on the structure. But the memorizer doesn’t change the risk consideration enough for people to take the lower coupon,” he said.

In addition, advisers are often reluctant to see new tweaks added to familiar structures, he noted.

“The more moving parts the more fee you will have embedded in the product. It’s also something you have to explain to a client. Clients don’t like complexity unless the economics change to their advantage,” he said.

Citigroup was the top agent this month with $657 million in 46 deals, or 28% of the total.

It was followed by Morgan Stanley and UBS.

Citigroup Global Markets Holdings was the No. 1 issuer, bringing to market 57 offering totaling $784 million, a 33.3% share.

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