Structured notes issuance $461 million for week amid bond, stock market sell-offs, Fed jitters

By Emma Trincal

New York, Jan. 19 – Agents sold $461 million of structured notes in 137 deals during a volatile week marked by a tech sell-off and rising interest rates not seen in a year, according to data compiled by Prospect News. It was the second down week of the year. Volatility as measured by the VIX index hit a high of 22 on Friday and has continued to climb since.

Temporary jitters

“We started the year with fears of Omicron, concerns over the Fed hiking rates and inflation,” Max Grinacoff, equity derivatives strategist at BNP Paribas, told Prospect News.

“It’s not a surprise to see the VIX on the top of our expected range. Rising rates are driving the jitters, and with the tech sell-off, you’re seeing a more elevated volatility.”

The analyst however does not expect the trend to last throughout the entire year in part because the Federal Reserve’s tightening has “already been priced in.”

“As we go through these motions, we could see a modest compression in volatility,” he said.

“When you look back at past rate hikes, in the 1990s and in 2016 for instance, you see the same jitters at first, but equity prices ultimately posted pretty strong returns at the end of the Fed hike cycle.”

Volatility spikes help the pricing of most structured notes, which are short volatility. Autocallables, which accounted for two-thirds of last week’s pricing, will benefit the most from volatility spikes via enhanced coupons and/or deeper barriers.

“The change in monetary policy provides opportunities for structured notes,” said a sellsider. But it represents a risk for the equity market and the economy.

All about Fed

The year has begun with a technology sell-off. The Nasdaq Composite index is down nearly 7% year to date.

“Tech stocks are getting crushed,” the sellsider said.

The sell-off and volatility in the sector could be good news if it remains contained, he said.

“We may see improvement in the pricing of structured notes with the rise in volatility,” he said.

“Omicron is noise. What matters is inflation and interest rates as well as tons of stocks with 40 to 50 P/Es.

“If the Fed hikes rates by 50 basis points in March, 25 bps in September and 25 bps again in December, or it may even do 50 bps two times, the pressure on tech stocks is going to be significant. It already is.”

Interest rates in the first two weeks of the year have surged. The 10-year Treasury yield rose from 1.63% to 1.88% on Tuesday, a 25 bps jump.

“Discount future cash flows are very high for tech or high P/E stocks, which is why they’re getting hit,” the sellsider said.

“Tech and biotech will lose steam while utilities, telecoms and industrials should benefit.”

Delicate balance

Other risks exist for the economy. While his outlook is relatively bullish, Grinacoff pointed to some macroeconomic headwinds.

“We see three key risks: the Fed hikes, the supply chain issues and the market’s high valuations. It’s the confluence of these factors that may pose a risk especially if the Fed hikes more and faster than anticipated to the point of choking off demand and growth precisely at a time when supply issues have not resolved themselves and valuations are high,” he said.

Another contributing factor to the current malaise is the rising inflation.

Inflation grew 7% year over year, according to CPI figures released on Wednesday, the sharpest 12-month increase in 40 years. Interestingly, stocks moved higher after the news, a sign that perhaps all the attention is on the Fed rather than on what is causing the Fed to tighten, some analysts said. More upbeat market analysts saw in the hot inflation data a sign that a strong cyclical recovery is underway.

Rotation

But inflation is now a real headwind, investment strategists, said. Even Fed chair Jerome Powell called it “a severe threat” last week when he appeared before the Senate Banking Committee for his nomination as Fed chair.

“Issuers of structured notes are going to look into exposure to rising rate and inflation,” said Grinacoff.

“This should lead to rotation trades into value stocks.”

“We expect to see selective sector picks where you see more cyclicality and growth potential such as industrials, energy, and semiconductors for instance.”

Some of the most used underlying assets can be found among semiconductors, according to Prospect News data. Several deals last week were structured on notes linked to Nvidia Corp., Micron Technology Inc., Advanced Micro Devices, Inc. and Intel Corp.

EOG Resources, Inc., BP plc and Schlumberger NV were the most visible energy names.

The Boeing Co. is an example of one popular pick in industrials.

Single asset underlying

Higher volatility levels may also decrease the need for worst-of payouts.

More autocalls linked to a single index rather than several have been spotted over the past couple of weeks, a sign of improved pricing conditions. Some provide contingent coupon rates equivalent to those seen on worst-of deals a few weeks ago, according to the data.

For instance, UBS AG, London Branch priced $16.22 million of one-year autocallables linked to the Invesco QQQ Trust, series 1 paying a quarterly coupon at the rate of 8% per year if the ETF closes at or above an 80% coupon barrier on the observation date.

The notes are automatically called quarterly. The downside threshold level at maturity is 80%.

The macroeconomic environment is likely to influence the type of underlying desks will be using to appeal to their clients.

“I think we’ll see an important sector shift. But the market will remain 90% equity,” the sellsider said.

Unpopular asset class

“There are tons of opportunities with commodities,” he said.

“Take energy. Oil is trading near 90, very close to the psychological mark of 100.”

He offered another example with industrial metals, which are in limited supply due to a lack of investment.

“With the pent-up demand, things are only getting worse. People want to spend money, and somebody has to produce those commodities. There is a lot of upside potential,” he said.

But this sellsider does not expect the asset class to regain favor among structured notes buyers any time soon.

“Commodities are an unloved asset class. Oil is very volatile. Prices are unpredictable. If OPEC decides to double the amount they’re pumping, all of a sudden, prices can drop from 80 to 60. And yet, opportunities exist. Oil is in backwardation. Pricing on the structuring side is fantastic,” he said.

Backwardation is when the current price of the underlying is higher than prices trading in the futures market. Such market environment makes the rolling of the futures contracts cheaper as they expire, providing additional yield to long positions.

“Food is also expensive. Futures in corn, wheat, coffee, sugar have all gone up,” he said.

“You could create notes on soft commodities. You have indices on it. But banks always avoid structuring notes on food. They’re accused of hungering the world. They get lambasted. That’s another lost opportunity.”

Rising interest rates may offer a more palatable prospect.

“What I would do right now is push for principal-protected notes.

“Rates are higher. You have more money at your disposal to buy the options. And it’s not like investors don’t have the appetite for it,” he said.

Top offerings

The S&P 500 index remained the underlying of choice last week as it usually is. But more deals on the index alone were seen than usual.

The top deal adopted a structure that has been popularized by BofA Securities. But the dealer was Goldman Sachs & Co. LLC., which priced $39.22 million of 14-month leveraged notes on the behalf of Bank of Nova Scotia. The payout is 3x on the upside up to a 15.51% cap and 1x the downside.

Goldman Sachs distributed another similar deal with the same issuer for $29.88 million. The only differences were the maturity extended to 18 months and the cap at 20.43%.

Morgan Stanley Finance LLC sold a dual directional note with a bearish bias in $24.09 million of one-year notes linked to the S&P 500 index. At maturity, the payout is one-to-one the index return capped at 9%. There is a potential for a 20% absolute return if the index falls at or above the 80% barrier level.

On Tuesday, ahead of Friday’s banks’ earnings releases, JPMorgan Chase Financial Co. LLC priced $24.03 million of 13-month digital notes linked to the S&P Banks Select Industry index.

The payout at maturity is 10% if the index is greater or equal to the 90% buffer level.

Otherwise, investors will lose 1.1111% for every 1% index decline beyond 10%.

Issuance volume for the trailing 12 months through Jan. 14 amounted to $92.63 billion in 24,603 deals, a 25.5% increase from the previous 12 months, which showed $73.8 million sold in 22,821 offerings.

The top agent last week was UBS with $184 million in 91 deals, or 40% of the total. It was followed by GS Finance and JPMorgan.

UBS AG, London Branch was the top agent with $102 million in 82 deals.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.