First week of 2023 kicks off with $309 million of reported structured notes issuance

By Emma Trincal

New York, Jan. 11 – Structured products agents started the year at a decent pace with $309 million sold in 41 deals, but a large portion of the tally came from a single $92 million trade, according to preliminary data compiled by Prospect News.

It was Citigroup Global Markets Holdings Inc.’s $92 million of 0.25% five-year equity-linked notes linked to Walt Disney Co. paying an annual interest rate of 0.25% quarterly.

The payout at maturity will be the greater of par and the alternative settlement amount. The alternative settlement amount is par times the final share price divided by the threshold price, 131.6% of the initial price.

$92 million hybrid deal

“It’s a pure synthetic convertible. The deal size is high, probably because it’s part of the core allocation,” said Brady Beals, director, sales and product origination at Luma Financial Technologies.

Last year saw an even larger deal of this kind – BofA Finance LLC’s $530.45 million of five-year cash-settled equity-linked notes tied to Merck & Co., Inc. Priced in May, it was the largest offering of the year.

Convertible replacement

Some Registered Investment Advisers (RIAs) with assets under management in excess of $3 billion have expressed interest in these products, noted Beals.

“We’ve been approached by some of them. They’re usually shops specializing in convertible bonds looking for alternatives to those securities. They want to get exposure to a company that doesn’t offer convertible bonds, or maybe the bonds are not liquid,” he said.

The tradeoff of the notes was “decent,” he said, as investors can participate in the upside with full downside protection.

“When you hit the 31% hurdle you still get the benefit of the stock upward move,” he said.

“I’m surprised that the coupon rate is so low. But it’s a principal-protected note and it has uncapped return based on a stock. Disney has been beaten up in the last two years. You could expect it to double in the next five years, which is feasible. If you have the bullish conviction, there are good reasons to do this deal.

“It’s a clever way to do a PPN on a stock. You’re just moving up the threshold to 31%.”

Slow start

Getting a first look at issuance for 2023 showed a relatively weak tally compared to the $500 million issued in 121 deals during the first week of last year. Recent numbers however will still be revised upward as the data remains preliminary. Still, sources said the action was limited.

“I haven’t seen much of new issues last week,” said a market participant.

“It’s currently pretty slow especially in the third-party space. I would say it’s a slow start of the year. It’s also the first week of the month. Each beginning of the month is slow. People are focused on getting deals out. I don’t know if it’s very different.”

Firms may also face difficulties.

“A lot of firms are laying off people. Maybe they’re having resources issues ... people on the desks may be scrambling.”

Some optimism

Looking ahead to 2023, most of last year’s challenges in the stock market remain unchanged.

The S&P 500 index finished the week up 1.45%. The week started negative, but the market rallied on Friday on a strong job report.

“People are feeling more optimistic right now than a month ago,” said Beals.

“The job report was a great catalyst last week. The numbers were neither too strong nor too weak. It could be a sign that inflation is easing and that the Fed may turn more neutral soon. That would be great for the market.

“And because the job report was still encouraging, investors became less anxious about a recession.”

Another factor making investors more upbeat was last year’s pullback, which lowered valuations.

“The S&P was down about 20%. There is increased conviction that it will be higher at the end of the year,” he said.

The structure breakdown last week was 31% for autocalls and 25% for leverage. Indexes represented only 45% of the total and stocks, 37%. But Citi’s behemoth deal on Disney skewed the market shares both for asset classes and structure types.

One-time autocall

In the index category, issuance volume for notes tied to a single index was twice greater than for worst-of indexes. These figures again were skewed by the presence of a large single-index notes offering.

It was GS Finance Corp.’s $60 million of four-year autocallable index-linked notes on the Nasdaq-100 index. A one-time autocall at the end of the first year delivered a 17% premium if the index finished flat or up at that time.

In the absence of a call, the payout at maturity is 1.25 times the index gain on the upside with full downside exposure.

The lack of any barrier or buffer did not shock Beals.

“Our clients are more focused on growth than on downside protection right now. Sentiment seems to be turning more positive,” he said.

Tighter barriers

Income notes always come with barriers. But barrier sizes may vary depending on clients’ sentiment.

“A deal I would have done until recently with a 30% downside protection, now I can make it at 20%,” he said.

“People are driven by the conviction that the market has bottomed so I can make my barriers a little bit shallower to get a higher coupon. There’s been a noticeable shift compared to two or three months ago.”

While short-term interest rates have increased, it has not been enough of a trend to incite investors to give up equity-linked income returns for risk-free coupons, he added.

“Some RIAs are telling us they’ve shifted some of their allocation to Treasuries. But these are tiny re-allocations. I don’t think it’s a major factor,” he said.

Follow the money

Shifts in allocations should help volume looking forward.

“As we know, a lot of notes are not getting called currently,” said Beals.

“The notes being issued right now are not necessarily coming from what was allocated to structured notes before. We see a fair amount of new money and also money reallocated from equity to structured notes.”

Fed’s balancing act

The main concern among equity investors and buyers of structured notes alike remained centered on the Fed, the market participant said. Uncertainty and volatility should persist, he predicted, which is not bad news for structured products issuance.

“We know the Fed wants to keep on cutting rates until they bring down inflation. But can they go far enough before something breaks leading to a deflationary spiral?” he said.

“The market sees the Fed pivoting to rate cuts soon. Be careful what you wish for. If you think a Fed pivot is going to drive the market higher, that’s kind of wishful thinking. A Fed pivot means the economy has collapsed and that’s not good. A soft landing would be the only positive scenario where you’d want to be aggressively long the market.

“I don’t see it coming.”

As a result, the equity market is likely to remain choppy this year, he concluded.

“It’s a good thing for our business. Investors are going to be more interested in downside protection than leverage. I see this trend already. Risk aversion is the key thing right now. People are no longer going to buy anything that’s going up.”

The top agent last week was Citigroup with three deals totaling $97 million, or 31.3% of the total.

It was followed by Goldman Sachs and Morgan Stanley.

The top issuer was Citigroup Global Markets Holdings Inc. with the same count as its affiliated agent.

© 2015 Prospect News.
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