Structured products issuance up 14.6% year to date; big index trades on single asset eyed

By Emma Trincal

New York, July 21 – 2021 is turning out to be a good year so far for structured products issuance.

The tally for structured notes issuance through July 16 is $44.28 billion, a 14.6% increase from $38.64 billion a year ago, according to preliminary data compiled by Prospect News. This pushes this year’s tally to fifth place since 2004, the time at which Prospect News began collecting issuance volume data. Last year was the eighth worst year on record. The best four years were 2018, 2017, 2008 and 2007 in declining order.

“If volume continues to be so strong this year, it’s because yields on bonds remain unattractive. More and more people are using structured notes as a substitute for bonds or equities, depending on the type of risk-return they’re looking for,” said a sellsider.

Quarter, week

This year’s first-quarter sales surpassed the second one so far with $23 billion versus $19 billion. Second quarter’s data however is still preliminary and is likely to be revised upward.

For last week, agents priced $333 million in 118 deals, on the heel of $760 million during the first week of the month, according to revised data.

It was another negative week for the markets. The S&P 500 index dropped 1% and the 10-year Treasury continued its surprising decline despite clear signs of inflation with June CPI and PPI soaring 5.4% and 7.3%, respectively, according to the Labor Department.

Mixed messages

As new cases of Covid rise, investors appear to be more concerned about a slowing of the economic growth rather than inflation. Weighing in the greatest risk between higher prices and lower growth has had an impact on sector allocations since last fall.

Covid-19 and its Delta variant “seems to be driving the stock market’s rotation this year,” said Charles Schwab’s chief global investment strategist, Jeffrey Kleintop, in a research piece.

“Economically sensitive, or cyclical stocks have outperformed when the global case count declined and the defensive, lockdown-era leaders outperformed when cases climbed.

The Delta factor

Rotation between sectors as a result of these conflicting market outlooks have less of an impact on note investors, the sellsider said.

“Despite the moves we’ve experienced lately, people who buy structured notes don’t respond to day-to-day changes in the market. A number of factors can contribute to a market sell-off: profit-taking, bad news, even good news. That’s the way the market operates.”

Perceptions of risk due to the pandemic directly impact interest rates, however. When hopes for a rebound fade, yields tend to decline as it has been the case over the past few weeks, which helps tech stocks whose valuations also benefit from higher yields, analysts said.

Rates matter

For the sellsider, volatility and interest rates are the decisive factors.

“Look, if we had a very sharp correction like we had last year, that’s something that would have a direct impact on our industry.

“What’s even more of a driver is interest rates. If rates are up, the bond market will become more attractive than it has been so far. If bonds start to yield 5%, it changes the game. The cost of not investing in equity is much lower. Now you have an incentive to go for bonds, which return your principal if the market falls. Taking equity risk is no longer enticing,” the sellsider said.

But so far, the long-term interest rates are coming down. The 10-year Treasury dropped to 1.3%, a noticeable difference from its 1.77% peak four months ago when inflation fears, not Covid fears, drove the market.

Equity indexes

Last week saw a resurgence of equity indexes due to the pricing of block trades. More than 82% of the week’s volume originated from equity-linked notes while stocks accounted for 21% of the total. Exchange-traded funds remained popular with 12% of the total.

Income-oriented notes continued to shine with $191 million in 96 deals, or 57.3% of the total. In essence those deals have a call feature, the majority of which being automatically triggered, but the use of issuer calls is becoming increasingly common.

As an illustration of investors’ adoption of discretionary calls, Barclays Bank plc issued a block issue of notes providing such feature. It was a $34.9 million issue of three-year contingent yield notes with daily coupon observation linked to the worst performing of the Nasdaq-100 index, the Russell 2000 index and the S&P 500 index.

The notes pay a quarterly contingent coupon at a rate of 8.5% per year if each index closes at or above its coupon barrier level, 70% of its initial level, on each scheduled trading day during that quarter.

The notes are callable quarterly.

The barrier at maturity is 70%.

Yield search

Despite lower volatility in the stock market, which has made coupons and terms less attractive, demand for structured notes remains strong this year due to investors’ focus on income.

“We’ve seen high issuance volume this year because cash yields nothing and bonds don’t provide any decent yield,” the sellsider said.

“Investors have to take more risk. Getting a higher income than what you find in the bond market is really what drives demand for structured products.”

But investors also use structured notes to reduce some of the risk associated with a richly valued stock market.

“Structured products with their downside protection are another way to play the equity market,” the sellsider said.

One underlier

Last week saw a surge of leveraged deals with big trades, pushing the volume in this structure type to 38.4% of the total, or $128 million in nine offerings, compared to less than 20% for the year-to-date average.

Of interest: nearly all leveraged issuance last week was built on a sole underlier – $126 million out of $128 million, the data showed.

The top two leverage deals were notes tied to the performance of the S&P 500 index only, including last week’s top deal issued by Toronto-Dominion Bank for $74.5 million.

This 14-month issue features 1.5 times the upside at maturity capped at 15.15% with full exposure to any index decline. TD Securities (USA) LLC was listed as the agent in the filing.

In addition, the largest stock deal was also a single-asset deal in the income-product type.

Royal Bank of Canada priced $10.67 million of one-year autocallable contingent coupon notes linked to Halliburton Co. stock.

The coupon is 14% per year based on a contingent barrier of 70%, which is the same as the final barrier.

Worst-of notes

Worst-of issues accounted for 57% of total sales last week. Most of those deals were tied to equity indexes and to a lesser extent to ETFs.

One exception was GS Finance Corp.’s $38.29 million of five-year autocallables linked to the SPDR S&P 500 ETF Trust and SPDR S&P Biotech ETF. The notes pay a contingent quarterly coupon of 6.94% a year if each ETF closes at or above a 70% coupon barrier. The first automatic call is after six months. The barrier at maturity is also 70%. UBS Financial Services Inc. and Goldman Sachs & Co. LLC are the agents.

On the other hand, the amount of worst-of deals tied to stocks was weak last week.

Sector bets

ETFs have helped note investors to express sector views.

Some sources believe that the constant balancing act between cyclical and tech stocks is not just a stock market phenomenon. It is also seen with structured notes, especially through the use of ETF underliers.

“We’re seeing tactical, short-term plays in this market,” a market participant said.

The Dow Jones industrial average hit an all-time high on Wednesday. After a sharp sell-off on Monday, shedding the benchmark 726 points, the market bounded back two days in a row.

Sudden volatility spikes tend to motivate some investors to strike deals to play a particular sector or stock.

“You have those very short-term sell-offs like Monday, but then people jump back in... they buy the dip the next day,” he said.

It’s during those short windows of time that tactical-oriented investors seek to strike sector plays to monetize the soaring volatility, he said.

So far, the trend has been bullish in the stock market. But this market participant said he worries about the current momentum.

“You have a lot of money that has been sitting on the sidelines. Defensive investors feel that they’ve missed the boat. Anytime you have a dip, even if it lasts only one day, people jump in,” he said.

“It’s always dangerous to dump money in an overbought market. You can only buy the dip for so long. In my opinion, it’s not a winning strategy to make money in the long term.”

© 2015 Prospect News.
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