Structured products weekly tally at $311 million as banks kick off Q3 earnings season

By Emma Trincal

New York, Oct. 20 – Structured products agents priced $311 million in 102 deals in the second week of the month, according to preliminary data compiled by Prospect News.

As banks kicked off the earnings season with strong results for the third quarter, the stock market finished higher. The Dow Jones industrial average rose 1.1% for the week. Volatility dropped to lower levels as the rally picked up in speed starting midweek when the big banks began reporting better-than-expected earnings, starting with JPMorgan on Wednesday, followed by Morgan Stanley and Bank of America on Thursday and Goldman Sachs on Friday.

Earnings, when robust, have a positive impact on stocks. They can also influence issuance volume of structured products, said a sellsider.

“Blackout periods prevent banks from pricing deals ahead of their earnings. Some banks have longer blackout periods. For some, it’s only one or two days; for others, it can be a full week before they can strike any new deal,” he said.

“It does reduce the number of days new deals can be issued.”

Q3 earnings season

Income deals last week continued to dominate, accounting for three-quarters of the issuance volume in 74 deals.

Equity-linked notes issuance made for half of total sales last week.

Exchange-traded notes, accounting for 20% of total sales, outpaced single stocks, which had a 16% market share. It was perhaps related to the earnings as well as choices of underlying stocks that may be more constrained.

“During the earnings, picking the right underlying can be a challenge,” the sellsider said.

“Last week you couldn’t pick bank stocks. But other companies are reporting their earnings too between now and the end of the month. For the deals we plan on striking at the end of the month, we have to straddle strike dates and earnings dates.

“It’s problematic but it doesn’t really affect issuance. The bigger impact is having blackouts because there are fewer days to do the deals.”

Last week’s top single stock deal was HSBC USA Inc.’s $15.5 million of 7.75% one-year airbag autocallable yield notes tied to Qualcomm Inc. with monthly interest payments. The agent was UBS.

VIX trending lower

The stock market dropped last month but has recovered in October, moving the VIX index lower than last month.

On Sept. 30, the VIX was close to 30. But it hit an intraday low of 15.72 on Friday. This decline, if it continues, will be felt by structured notes buyers, the sellsider said.

“It’s going to have an impact on pricing obviously even though it’s the implied forward volatility that matters in in pricing deals, not the VIX. The VIX is the spot. But the two tend to move in the same direction, so usually when the VIX is lower, so is the implied forward,” the sellsider said.

Income notes benefit from higher volatility levels as the coupon and barrier are created via short options positions.

“We’re already seeing a deterioration in the terms. In September, we saw a little bump in the coupons. But now, coupons are dropping back to where they were in August and July,” the sellsider said.

Fixed rates

There have been some income-notes with fixed coupons recently, such as the HSBC deal on Qualcomm.

“If the vol. continues to trade downwards, those will be harder to price because you usually need higher volatility to create the fixed interest rate,” he said.

Another example from last week was Credit Suisse AG, London Branch’s $22.39 million one-year 7% STEP Income Securities linked to Apple Inc. Interest is paid quarterly.

If the shares finish at or above the 107% step level, the payout at maturity will be par plus 6.35%.

Investors will be exposed to any losses. The agent is BofA Merrill Lynch.

Going back the week before, GS Finance Corp. priced an eye-catching $10.07 million deal of 6.8% trigger callable yield notes due Jan. 11, 2023 linked to the performance of the Russell 2000 Value index and the S&P 500 index.

The interest is paid monthly. The notes are callable monthly after three months. The barrier at maturity applied to the worst-performing index is 60%. UBS is the agent.

“This one is quite interesting,” the sellsider said.

“Certainly, the non-correlation risk is there. But usually, you need more volatile indices to get the guaranteed coupon. On top of that, a 6.8% fixed rate on indices is pretty impressive without mentioning the 60% barrier.”

Index combinations

Issuers are getting more and more creative with correlations, putting together new combinations in their income notes on worst-performing indexes, according to the data.

The use of the S&P 500 index, Russell 2000 and Dow Jones industrial average is no longer the main recipe.

Plays on value mixing large-cap and small-cap benchmarks is becoming increasingly visible such as previously mentioned GS Finance deal as well as last week’s issue by Barclays Bank plc for $14.37 million of three-year autocallable contingent coupon notes on the lesser performing of the iShares S&P 500 Value ETF and the iShares Russell 2000 Value ETF.

JPMorgan Chase Financial Co. LLC structured a $2.21 million deal on the same theme with a three-year product linked to the worst of the Dow Jones industrial average, the Nasdaq-100 index and the iShares Russell 2000 Value ETF. The notes carry a 14.9% annualized call premium with autocall after one year and a 70% barrier at maturity.

Little by little, international equity benchmarks are making a comeback, especially the Euro Stoxx 50 index.

Bank of Montreal for instance priced $3.12 million of six-year callable notes linked to the Euro Stoxx 50 index, the Nasdaq-100 index and the Russell 2000 index with a contingent quarterly coupon of 9.2% per year based on a 70% coupon barrier. At maturity, the repayment barrier is set at 60%.

Combining U.S. and non-U.S. indexes adds more dispersion risk, but it has been done before. It does not hurt to mix indexes with different market capitalizations as well.

Barclays Bank offered an example last week with the pricing of $6 million of three-year autocallable contingent yield notes linked to the performance of the Nikkei 225 index and the Russell 2000 index.

The quarterly contingent coupon is at 6.82% per year based on a coupon barrier of 70%. After six months, the notes are automatically called if the worst-of is at or above its initial level for that quarter. The barrier at maturity is 70%. UBS is the agent.

Premium extraction

“These deals are coupon-driven. Broad-based indices are no longer enough to generate attractive yields,” said the sellsider.

“You really have to mix different combinations. It could be growth versus value, U.S. versus international equity, large-cap and small-cap or any other combination.”

Issuers even mix different criteria within those categories, he added.

“When volatility is not high enough, you have to play with correlation risk.”

None of those combinations are new. But they seem to flourish now as the market is recovering from a brief sell-off, rallying again close to its recent highs.

Near record territory

In late afternoon session on Wednesday, the S&P 500 index was trading less than 9 points from its all-time high of Sept. 2.

With ETFs, one of last week’s trends was mixing a broadly diversified ETF with a sector ETF.

JPMorgan Chase Financial used this technique with the pricing of $26.68 million of five-year autocallables on the SPDR S&P 500 ETF Trust and SPDR S&P Regional Banking ETF, paying a 7.12% contingent coupon with a 60% downside threshold. UBS is the agent.

The same issuer also priced $12 million of five-year autocalls on SPDR S&P 500 ETF Trust and the Energy Select Sector SPDR Fund with a 7% contingent coupon and the same 60% barrier. The deal was also distributed through UBS.

Digital, dual directional

A few other structures emerged last week including digital and absolute return notes.

On the digital side, JPMorgan Chase Financial showed $15 million of one-year digital contingent buffered notes linked to the least performing of the S&P 500 index and the Russell 2000 index.

The digital payment is 8.5% payable if each index finishes at or above its initial price.

The final barrier is set at 85%.

About $10 million worth of absolute return notes priced last week in eight deals, coming mostly from UBS and JPMorgan.

“People are looking at a variety of ways to generate yield. I see more digital, more absolute return, step down products, step up products, anything you can think of to get yield enhancement,” a market participant said.

Big year, up 27%

This post-pandemic year has been very strong for the structured note industry.

So far this year, the tally is $70.22 billion through Oct. 15, a 27% jump from last year’s $55.25 billion. This figure will be revised upward as the data remain preliminary.

“This huge growth is due to the lower interest rates. Everybody is looking for yield, which you can’t find anywhere,” the sellsider said.

“Even if you’re really far out the curve, you can’t find very attractive rates.

“Last time I checked high-yield spreads were at record lows. It wasn’t a long time ago.

“Structured notes on equity have become a popular way to generate income.”

The top agent last week was UBS with 64 deals totaling $158 million, or 51% of the total.

It was followed by JPMorgan and Goldman Sachs.

The No. 1 issuer was JPMorgan Chase Financial with $109 million in 20 offerings.

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