Structured notes issuance $1.42 billion for week, aided by BofA’s $566 million contribution

By Emma Trincal

New York, Aug. 31 – Structured products agents priced $1.42 billion in 233 deals during a tumultuous week ended Friday. BofA captured 40% of the total through the pricing of $566 million in 33 offerings, according to preliminary data compiled by Prospect News.

The stock market sold off for a second straight week in response to Federal Reserve chairman Jerome Powell's hawkish speech at the Jackson Hole Fed symposium on Friday.

The pullback in the second half of August contrasted with a strong bounce since mid-June, which at some point brought the averages back to bull market territory. This reversal comes on the heels of a bear market during the first half of the year which drove the S&P 500 index down 24.5% by mid-June.

Gauging sentiment

Advisers are divided on how to interpret the market moves. For some, a recovery is in sight and uncapped participation is the answer. Others remain conservative, sticking to income products, which don’t require any growth but offer some barrier protection on the downside.

The shift was reflected in last week’s distribution of structures: leveraged notes accounted for 38% of total notional while autocallables made for 34% of it.

The relatively high representation of leveraged notes reflected the strong presence of BofA, which routinely offers block trades on this structure.

As an example, this agent priced the top deal of the week in Bank of Nova Scotia’s $83.6 million of 14-month Accelerated Return Notes linked to the S&P 500 index. The payout is triple any index gain, up to a 19.44% cap. Investors will be exposed to any index decline.

“We’re very neutral and our clients are not bullish. They’re skeptical,” a sellsider said.

“We don’t see a huge rally. We don’t see a huge crash because the Fed is monitoring. Powell is trying to achieve soft landing.

“Equities are going to be stuck, and that speaks for more autocalls.”

Others were more cautious.

“Investors are turning bullish,” said a market participant.

“They’re forgetting all the troubles and the risks that are still out there. In June, July even in the first half of August, we rallied. But now, we’re going through a broad-based sell-off. Investors should look for protection, but many are looking for more upside.”

One-time autocall

Some investors are willing to get a one-time exposure to reinvestment risk to obtain a leveraged uncapped payout at maturity. This is what the second top deal of the week allowed them to do in a structure that has become increasingly popular.

GS Finance Corp. priced such a deal in $71 million of three-and-a-half-year autocallable index-linked notes tied to the Nasdaq-100 index.

The notes will be called at par plus a 14% call premium if the index closes at or above its initial level on Aug. 28, 2023. If the notes are not called, the payout at maturity will be par plus 1.6 times the index gain. The downside offers an 80% barrier.

Index-linked notes accounted for 71% of total notional, last week compared to 12% for stocks, 10% for ETFs and 7% for rates.

Daily coupon observation

The top worst-of deal was brought to market by BofA Finance LLC with UBS and BofA Securities, Inc. acting as agents. The $59.92 million of trigger callable contingent yield notes due Feb. 26, 2026 linked to the worst performing of the Nasdaq-100 index, the Russell 2000 index and the S&P 500 index featured a 65% coupon barrier with daily coupon observation, an issuer call observable quarterly and a 55% barrier at maturity. The quarterly contingent coupon was 12.45% per annum.

Worst-of vs. single asset

Nearly all of the worst-of on indexes were applied to income products while single index underliers were used for leveraged notes.

This is not new, and the sellsider explained why.

“With autocalls, you want to maximize the coupon and that’s why you’re using several indices,” he said.

“With leverage, you want to maximize your return while expressing a specific view on a specific index.”

The market participant offered an explanation based on correlations.

“I see worst-of both in income and growth notes. That said, worst-of for barrier autocalls make sense because you’re not trying to capture a return. Your only concern is the downside,” he said.

“If you have three indices, all three of them are likely to drop the same way and by the same amount simply because correlations are high on the downside, especially if you’re dealing with three U.S. indices. It’s on the upside that you have more dispersion. But you don’t care about the upside. The upside is your coupon.”

Energy bubble

ETF underliers last week showed a fair amount of broadly diversified index funds, such as the SPDR S&P 500 ETF Trust. Sector plays were secondary at the exception of energy bets.

“There are tons of energy deals,” said the sellsider.

“Everybody talks about the energy crisis. There is an energy crisis in Europe, there is an energy crisis in China and there is an energy crisis in the U.S. It’s a crowded trade.”

“If a pharmaceutical company had just invented a treatment against cancer, everybody would do deals on pharma stocks.”

The popularity of energy bets is understandable. Since their respective bottoms a year ago, the Energy Select Sector SPDR fund has gained 75% and the SPDR S&P Oil & Gas Exploration & Production ETF surged more than 80%. Those two funds are the most commonly used in equity-linked notes with energy exposure.

Hedging inflation

While Powell made it clear on Friday that he is determined to fight inflation, no one expects the Fed to be able to bring it back down to the 2% goal anytime soon, the sellsider said. In the meantime, investors are using structured notes to hedge against higher prices and rising rates.

“Some of the best hedges against inflation are structured products tied to bonds. We see them in Europe, not so much in the U.S. Maybe it’s a regulatory issue, I’m not sure,” the sellsider said.

“Certainly, a very popular alternative are floaters. They’re not bad as a hedge.”

$50 million floater

An example was Citigroup Global Markets Holdings Inc.’s $50 million of 13-month fixed-to-floating rate notes on the two-year U.S. dollar SOFR ICE swap rate with monthly interest payments.

The initial interest rate is 4.75% per year. Beginning on Dec. 30, the interest rate will be the two-year U.S. dollar SOFR ICE swap rate plus a spread of 35 basis points, subject to a floor of 0%.

The payout at maturity will be par.

The case for autocalls

The sellsider pointed to the search for yield as one of the best anti-inflation strategies.

“At the end of the day, autocalls remain one of the most efficient defenses. If you can get a 12% coupon from an autocall on three indices and if inflation is at 9%, at least you get 3%. You’re not totally dispossessed of your purchasing power,” he said.

“Since inflation is not going to disappear overnight, I’m pretty confident that autocalls will make a comeback.”

That would be good news given that the main factor behind this year’s 16% decline in structured notes issuance derives from a steep drop in autocallable sales.

Agents have sold $54.87 billion of structured notes this year through Aug. 26 compared to $65.19 billion a year ago, a $10.32 billion difference.

The $23 billion decline in autocall issuance is much more drastic: sales have plummeted to $18 billion this year from $41 billion last year.

The sellsider said he was optimistic about the future of autocall issuance.

“Autocalls have not been called for a while and that’s why sales collapsed,” he said.

“But now they’re nearing maturity. Many of them are still above the barrier and will be at maturity. You still get your cash. The barrier has worked. It was the right protection. Why not doing it again? I think this is how people will look at it. We should see a lot of money reinvested.”

Moving back up

Overall, he expected more structured notes sales by year-end.

“Things can only get better. The market has kind of bottomed. P/Es are lower. People’s expectations are lower.

“The time when everybody thought that each new tech company would be the next Google is over,” he said.

The top agent after BofA Securities was UBS with $269 million in 66 deals, or 18.9% of the total.

It was followed by JPMorgan and Goldman Sachs.

The No. 1 issuer was Bank of Nova Scotia with 14 offerings totaling $308 million, a 21.7% share.

Aside from the top offering, Bank of Nova Scotia last week priced a few other big trades. Those included $45.87 million in capped leveraged notes on the S&P 500 index and a $40.38 million issue of capped notes with absolute return on the S&P 500 as well.

© 2015 Prospect News.
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