Structured notes tally up 13% in first half of October amid inflation, geopolitical concerns

By Emma Trincal

New York, Oct. 18 – The first two weeks of the month started on a high note with issuance volume up 13% to $1.86 billion in 431 deals through Oct. 13, versus $1.65 billion during the same time in September, according to preliminary data compiled by Prospect News. The uptick corresponded to a mild equity market recovery after a volatile September, which saw the S&P 500 index drop 5.4%.

It is hard to determine if volume gets pushed up with equity rallies, which trigger calls, or by volatility spikes, which add premium and improve pricing, a sellsider said.

“I’ve always struggled to find an answer to this question,” the sellsider said.

Top months

Part of the answer may lie in the correlation between issuance volume and stock market performance month by month.

The top three months this year for structured notes sales have been March, August and February. All three periods were characterized by equity market sell-offs.

In March, sales of structured notes amounted to $9.13 billion amid the regional banking crisis, the data showed.

In August, when volatility advanced and the stock market dropped and then recovered, notional sales accounted for nearly $9 billion. Finally, February, another negative month for stocks, saw the sales of $8.5 billion of notes.

“The best periods to sell products are when volatility is up. That’s when you get the best entry points, the best terms,” said a market participant.

Tough market

The market’s response to the new war in the Middle East was muted last week. Higher-than-expected inflation data had a bigger impact, but overall, the S&P 500 index ended up mostly flat, down 0.5%.

Complete issuance data for last week was not available at press time.

“It’s a tough market right now,” said Ed Moya, senior market analyst at multi-asset trading firm Oanda.

“The economy is pretty strong, so the market sees the potential for a soft landing. But the Fed will raise rates a little bit more even though they signaled they’ll hold it during their next meeting next month. It’s a very complex picture, but the market doesn’t really expect any rate cuts before July,” he said.

One positive factor, which may explain the under-reaction to the new war in the Middle East, came from the big U.S. banks, notably JPMorgan, Wells Fargo and Citigroup, which released strong earnings last week, he added.

While bond yields dropped earlier last week in what some saw as a flight to quality, they return to their rising mode.

Yesterday, the 10-year Treasury yield almost touched 5% hitting an intraday high of 4.9280.

“The bond market is selling off because of liquidity concerns around Treasuries,” said Moya.

“The Fed is not buying. Demand from China and Japan is not as strong. There’s a lot more issuance coming.”

Structures, asset classes

This month’s top structures remained callable notes (55% of the total) followed by leverage (17%). While the issuance volume for callable products rose 17% from September, leveraged notes sales dropped 29%.

Asset classes this month saw equity indexes at $1.35 billion, making for 73% of the total.

Single stocks represented more than 15% of the notional with $280 million.

The first half of the month, while encouraging, does not offer a complete picture yet. Only the full cycle with the end of the monthly calendar will determine if there is a trend or not.

Year-to-date volume

Issuance volume for the year amounted to $73.43 billion through Oct. 13, a 2.8% decline from last year’s $75.56 billion. The deal count was down 24% to 17,579 from 23,052.

“Our industry is facing a number of headwinds. Volatility has been trading sideways for some time, and we now have the competition of fixed-income instruments. I’m not just talking about Treasuries but also money markets, even bonds,” the sellsider said.

“If you’re showing an autocall with an 8% contingent coupon, that’s only 2.5% over the risk-free rate. Investors have reached a point where they don’t want to take the market risk for an extra 2.5%,” he said.

The other difficulty has been the low volatility recorded this year despite the mounting uncertainty around interest rates, inflation, recession and geopolitical risks.

Single names

“The VIX has been moving sideways. It rose in March at around 30 during the banking crisis but it didn’t last. Since then, it has been very contained,” the sellsider said.

The range for the VIX index over the past 12 months has been from a high of 32.59 exactly a year ago to a low of 12.68 a month ago. But in between, the volatility index has been trading sideways.

“In order to get decent coupons, people strike single names, even via worst-of, but they don’t do it massively,” he said. Risk was one obvious reason for the limited use of single stocks compared to indexes. Another one was the tactical aspect of those investments.

“Single names are very news-dependent. It’s not something you do on a regular basis. It’s not part of your asset allocation,” he said.

Single-stock issuance this month rose 15% from last month.

The top “stock” deal was brought to market by Barclays Bank plc in a $22.66 million issue of three-year autocallables on Uber Technologies, Inc., with Morgan Stanley acting as an agent. A quarterly annualized coupon of 12.85% was payable above a coupon barrier of 50%. The autocall was observed quarterly. The principal repayment barrier was also 50%.

Sales of index-linked notes rose 30% this month from September.

The largest index offering was Royal Bank of Canada’s $104 million of three-year digital notes linked to the S&P 500 index. The payout was 21.65% if the index finished above 90% with 10% geared buffer below that level.

Principal protection

Investors have shown various approaches to risk, sometimes going to extremes. On the conservative side, some popular deals have been principal protection with unlevered and capped upside participation.

Bank of Montreal for instance priced a small issue of 18-month principal-protected notes tied to the S&P 500 index paying par plus any index gain subject to an 18.5% cap.

Adding an inch of upside leverage but extending the duration to five years, GS Finance Corp. priced $1.02 million of principal-protected notes linked to the S&P 500 paying 1.1x any gain and capped at 88.7%.

“The second one doesn’t make much sense to me because the longer you go, the lower the chances of finishing negative,” an adviser said.

“In general, I don’t like those one-to-one principal-protected notes with a cap. That kills any chance to outperform on the upside. You only outperform on the downside, and most of the time, you would be better off with a buffer or a good barrier. I’ve never seen one that makes financial sense.”

Reaching for yield

On the other side of the risk spectrum, some investors are buying notes tied to the worst-performing of several stocks.

GS Finance for instance priced last week $1.91 million of autocallable contingent coupon notes tied to the worst of Freeport-McMoRan Inc., Advanced Micro Devices, Inc., Tesla, Inc., Nvidia Corp. and Shopify Inc. The contingent coupon was 15.25% and the coupon barrier and barrier at maturity were both at 68%.

The use of American barriers (daily knock-in) while still rare is sometimes employed as a remedy against dull coupons.

As an example from last week, UBS AG, London Branch priced $2.4 million of 15-month autocallable contingent yield notes with daily close monitoring knock-in tied to the worst-performing of the Nasdaq-100 index, the Russell 2000 index and the VanEck Gold Miners ETF. The notes pay a contingent coupon of 17% per annum based on a 65% barrier and are autocallable above 105%. At maturity, investors lose the benefit of the barrier if the worst-of breaches the 65% level on any trading day during the life of the notes.

“Those American barriers of course add a lot of risk, but you get better terms,” the sellsider said.

On the other hand, geared buffers, another kind of yield-buster, have gained acceptance among advisers. Of the total notional amount of leveraged notes which priced in the first half of October, 51% came with a geared buffer, according to the data.

The sellsider was not surprised.

“Buffers are expensive, and people have been avoiding barriers. When you lose 30% or 35% of your client’s principal, it’s a big deal. It’s a big deal in terms of your relationship with them but also from a business standpoint since the premium of your insurance is going to rise. Advisers after a big loss like that don’t want to lose money. By striking a leveraged buffer you reduce your downside risk, and the pricing is better than a normal buffer,” he said.

The top agent for the month was UBS with 95 deals totaling $327 million, or 17.7% of the total.

It was followed by JPMorgan and Morgan Stanley.

JPMorgan Chase Financial Co. LLC was the No. 1 issuer with $306 million in 79 offerings, a 16.6% share.

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