Structured notes issuance $221 million for week amid stock rally, settled bond market

By Emma Trincal

New York, April 21 – Agents priced $221 million of structured notes in 112 deals during another strong week for the equity markets, which saw the stock averages rising to record highs, according to preliminary data compiled by Prospect News. Equity indexes pricing in an autocallable format dominated the flow.

First-quarter sales

Recently updated data placed notional sales for March in second position with $7.2 billion, just behind January’s $8.1 billion and ahead of February’s $6.88 billion. January’s sales rose by a third from the year before, while they slightly declined (-5%) in February and remained flat in March. The deal count was up in double-digit terms in January and February and fell 6% in March.

Volume growth overall is up 3% to $22.2 billion in the first quarter versus $21.54 billion during that time last year.

The number of deals rose to 6,496 from 6,010, an 8.1% increase for this first quarter.

“I’m not sure why March was so strong. It’s probably a seasonal factor,” a former syndicate manager said.

“But the fact that January was a big month is not all that surprising. It’s usually the case. People sit on their hands at the end of the year and new money goes to work at the beginning of the next.”

In the first quarter of last year, January was also the top month, recording $7.03 billion in volume.

It is too soon to have a clear picture of what April sales will look like. Steve Sosnick, chief options strategist at Interactive Brokers, observed in his weekly commentary that money is not flowing out for taxes this month as the deadline has been pushed to May 17, which may be encouraging. So far, a little bit less than $1 billion has been priced in the first half of this month, according to the preliminary data, which will be revised upward.

Stable yields

In the equity market, last week’s sentiment was bullish with strong earnings results and good economic news, such as a robust retail sales report and a decline in jobless claims for the week. These headlines should have pushed the 10-year Treasury higher as has been the case in previous weeks when news headlines suggesting an acceleration of the economy or inflation propelled yields higher. The 10-year Treasury yield rose as high as 1.77% on March 30. But bond yields did not rise last week.

“It was a surprise. I guess despite the positive economic news, people are still concerned about virus control, supply chains, shutdowns and the slow vaccine rollout in other parts of the world,” said the former syndicate manager.

“I would read that in terms of investors seeking some safe haven, a flight to quality into Treasuries.”

The Federal Reserve’s accommodative policy does not help clarify the mixed price action on the bond market, he added.

“I guess the only way we’ll find out what the 10-year Treasury is worth is when the Fed stops buying all of them,” he said.

Two-thirds in autocalls

There is no “flight to quality” in structured products simply because most of them already have embedded downside protection against market risk, he noted.

Yet the overwhelming bid on autocallable notes is not a reach for protection.

“It’s a yield grab. A lot of this fascination with autocalls is coming from a reach for yield. Autocalls to me are an aggressive fixed-income posture with strong downside protection.”

During the first quarter, autocallable issuance amounted to 65% of total sales with $1.156 billion in snowballs and $13.256 billion in Phoenix autocallables. Leverage on the other hand had a 19% market share with only $4.2 billion issued.

Within the leverage category, a third was sold with no downside protection.

Some equity analysts, such as Sosnick, see new levels of “complacency” among investors as reflected by the low volatility measured by the VIX index.

“The VIX is coming to lower levels, which are not in absolute numbers the ones we saw ahead of blowups in the past, but it’s still low on a relative basis,” he said.

“The low level of the VIX is due to a lack of demand for hedging rather than a lack of demand for speculation.”

Managing expectations

Nick Johal, managing director at Catley Lakeman Securities, a U.K.-based distributor of structured products, agreed that autocallables do not isolate investors from the risk found in equity markets.

“There’s definitely downside risk and it’s a matter of managing expectations. Our clients are discretionary fund managers. The mark-to-market of the securities is important to them. They need to understand the product to make sure they allocate the securities the right way,” he said.

“The sell-off last year at the end of the first quarter was an acid test. The U.S markets rebounded very strongly, and most U.S. notes got called. But it took longer for the U.K market to recover. Even in the second half of last year, autocalls here in the U.K. had no chance of calling.”

But they did this year.

Value versus growth

After heavily betting on technology names earlier this year, structured notes buyers have reallocated to assets playing out the “recovery trade.” Stocks of cruise lines, airlines, hotels, energy and banks have been in high demand as the Nasdaq performance turned choppy, especially after Feb. 16, when it peaked.

Fears of inflation have also contributed to the rotation as tech stocks are more vulnerable to rising rates and inflation. But there has been some back and forth lately, according to analysts. Last week’s bond market did not react to inflationary signals, suggesting that perhaps, investors have already priced in higher rates or perhaps, the assumption is that inflation will only take hold gradually.

One advantage for investors in the U.K. when value investing is in favor is the fact that the FTSE 100 index has a “value bias,” said Johal.

“Most of our products are in the index-space. It hurt us last year since we lagged the S&P. But it has helped us this year as the shift to value has been unfolding. What we find interesting is to play on different factors than just volatility and dispersion.”

He mentioned a popular trade in the U.K. based on dispersion called “Palladium structure.”

Palladium notes

“You’re basically short an index and long a basket of stocks and you want the stocks to move higher,” he explained.

“It’s a dispersion play. You’re getting paid based on the relative value of the basket versus the index.

“Depending on the market we may look at value stocks or growth stocks. All you want is the basket to outperform the index.

“And because the stocks need to move, it’s also a long volatility position.”

Another benefit to investors is the non-directional nature of the trade, he said.

Autocallable structures are short options. When volatility is low as it is today, terms are not so favorable.

This is one of the reasons single-stock issuance has expanded so much in the United States.

During the first quarter, $4.77 billion of single-stocks-linked notes were brought to market, an 86% increase from last year’s $2.56 billion, according to Prospect News data.

“We’re looking for alternatives in how we diversify our products. Volatility, correlations with worst-of are one approach. But you can also incorporate non-directional factors, such as dispersion, and get exposure to the absolute difference between two assets,” he said.

Last week’s top deals were income-oriented offerings tied to the worst of three indexes.

Issuance of equity-index-linked notes represented 60% of the total last week, versus 25% for stocks and 15% for ETFs.

Barclays priced $34 million of callable notes linked to the worst of the Nasdaq-100 index, Russell 2000 index and S&P 500 index. The maturity was three months short of three years. UBS Financial Services Inc. and Barclays were the agents.

The notes offered a contingent coupon of 10% a year if all indexes remained above a 65% coupon barrier on any day during the quarter. The point-to-point barrier at maturity was 65%.

Recovery bet

ETFs continued to be in favor last week. Volume in this asset class more than doubled in the first quarter to $2.36 billion from $1 billion last year. ETFs this past quarter make for more than 10% of sales versus less than 5% a year ago.

An example of an ETF offering playing on the value/recovery theme was JPMorgan Chase Financial Co. LLC’s $22.17 million of three-year autocallable notes linked to the iShares Russell 2000 Value ETF and SPDR S&P MidCap 400 ETF Trust. Both the coupon and final barriers were set at 70% of initial price. The contingent coupon was 6.27% a year. UBS Financial Services Inc. and J.P. Morgan Securities LLC were the agents.

Snowball with step down

GS Finance Corp. priced an interesting snowball structure with a step down at maturity. The $20 million of five-year autocallables is tied to Activision Blizzard, Inc., DocuSign, Inc. and Wells Fargo & Co.

After one year, the notes will be automatically redeemed at par plus 18.1% annualized if the worst-performing stock closes at or above its initial price on any annual observation date.

As with any snowballs the call premium accumulates over time, but in this case, the final threshold drops substantially from par. If the worst-performer finishes at least at 60% of its initial price, the payout at maturity will be par plus 90.5%.

Goldman Sachs & Co. LLC was the agent with JPMorgan as placement agent.

“This is more of a speculative trade with a very high yield. Single stock autocalls have a high-risk, high-return profile. Add to that some high volatility and low correlations and you can price a very competitive premium,” a market participant said.

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