Structured products issuance volume holds well with $1.85 billion in two weeks amid banking turmoil

By Emma Trincal

New York, March 29 – Last week marked the second week of a banking crisis, which began with the failure of two regional banks on March 10 and the merger of two giant Swiss banks two days later.

During each of those volatile weeks, the stock market ended higher. In addition, issuance of structured notes was strong at least during the worst and early stages of this banking chaos.

Fear is up, so is the market

On the week of March 12, which kicked off with a sell-off on the news that UBS had purchased for $3 billion its rival Credit Suisse in a merger engineered by the Swiss regulators, the S&P finished up 1.43% and the Nasdaq, 4.41%. Data compiled by Prospect News for that week showed the issuance of $1.66 billion in 340 deals.

Last week’s tally was less impressive with $192 million issued in 69 deals, according to the data. But figures are still preliminary and will be revised upward.

Then again, uncertainty was high with the focus on the Federal Reserve’s 25 basis points hike and renewed jitters about Deutsche Bank’s widening credit default swap rates. And yet, stock prices continued to rally with the S&P 500 index up 1.4% on the week and the Nasdaq, 1.7% higher.

“I wouldn’t have expected the stock market to be up in the past couple of weeks and structured notes issuance to be so resilient,” said a sellsider.

“It’s a surprise given that investors were kind of freaking out after the fall of SVB and Signature Bank followed by UBS taking over Credit Suisse.”

He brought up two explanations.

Regulators, speculators

“It’s possible that investors became quickly confident in the banks issuing the notes because their credit was not affected. They saw that the big banks were protected by the regulators, which restored some confidence,” he said.

“You also have some buyers of structured notes who wanted to take advantage of higher credit spreads and higher volatility, both leading to better terms.

“There is a bunch of investors out there who have become so seasoned in structured notes, they can perceive changes in terms, and they jump in as soon as volatility spikes.”

Big old deals

A number of large deals hitting the market two weeks ago also contributed but only partially to the strong issuance volume. Two of them, which were previously reported, were Royal Bank of Canada’s $121.84 million of two-year fixed-to-floating rate notes on the two-Year U.S. Dollar SOFR ICE swap rate and Citigroup Global Markets Holdings Inc.’s $66.41 million of six-year synthetic convertibles linked to Halliburton Co.

“Those big fixed-to-floating deals are sold to institutions who need to manage their cash positions. It could be banks, corporations or insurance companies,” the sellsider said.

“It’s for any of those large institutional investors who want to hedge their exposure to interest rate risk, which is a good idea right now.”

For noteholders, those products provide additional income and an inflation hedge, he added.

Short, very short

No large deal was spotted last week at press time. But a few trends were noticeable.

The first one was the use of issuer callable notes over short maturities with the ensuing brief no-call period, typically three months.

For instance, Canadian Imperial Bank of Commerce priced last week $11.46 million of 15-month 9.83% trigger callable yield notes on the S&P 500 index. Interest is payable monthly.

The notes are callable on any monthly coupon payment date after three months.

The principal repayment barrier at maturity is 65%. UBS is the agent.

Another example from last week: Citigroup Global Markets Holdings’ $1.89 million of 18-month callable contingent coupon securities linked to the worst of the Nasdaq-100 index, the Russell 2000 index and the S&P 500 index. The contingent coupon is paid monthly at a rate of 9.1% per annum based on a 70% coupon barrier.

The issuer may call the securities on any monthly review date starting June 20. The barrier at maturity is 70%.

The sellsider said that the cost of the embedded options on rates could explain issuers’ tendency to structure those short no-call periods based on the inverted shape of the yield curve.

“The banks want to be able to get funding at a better rate. That’s their goal. The short end of the yield curve is upper-sloping. The banks want to have the option to take advantage of declining rates after three months,” he said.

“Right now, the market is pricing that rates are going to go down. It makes the price of call options very cheap.

“Banks can buy those calls to hedge interest rate risk. If rates end up going up, not down, they have the option to call. For them, it’s a cheap hedge. Investors on their end get better terms until the notes are called if they are.”

Sometimes the notes are just short duration without a call option taking the shape of a traditional reverse convertible.

UBS AG, London Branch for instance priced $499,920.82 of 16.71% annualized trigger yield optimization notes due June 27 linked to the SPDR S&P Oil & Gas Exploration & Production ETF.

Interest is payable monthly. The barrier at maturity is 80%.

Banks on banks

Another trend was the multiplication of deals linked to single stocks of big banks.

JPMorgan Chase Financial Co. LLC priced $2.5 million of a 13-month digital note issue on Bank of America Corp. UBS sold one-year autocallable notes on the Charles Schwab Corp.

Morgan Stanley Finance LLC issued $5.56 million of autocallables on the stock of Wells Fargo & Co.

Separately, Royal Bank of Canada has announced the offering of three-year autocallable contingent coupon notes on Citigroup Inc. as well as another one linked to Goldman Sachs Group, Inc. These are only a few examples among many other deals.

“It’s driven by clients’ appetite for the coupons,” the sellsider said.

“Volatility is high around some specific stocks particularly the stocks of financial companies. So naturally, the coupons on these stocks start to increase.

“There is a set of buyers who are not looking at the whole world. They’re looking at the underlier with the lenses of structured note pricing. They keep moving around from name to name and from sector to sector happy to take more risk if they can boost the yield.”

Bid on income

The drive to monetize volatility was evidenced by the recent growth of income notes as a share of total notional in the past two weeks, especially when compared with leverage. Autocallable notes made for 38% of the total notional combined for the past two weeks versus 18% for leverage and 12% for fixed-to-floating notes.

As always, the autocallable structures were for the most part based on equity indexes. This underlying type represented 71% of the total against 12% for stocks and ETFs and 12% for rates.

Deja-vu

While bank runs and credit fears seem to be on pause for now, some advisers remain unsettled by the sudden demise of some banks in a matter of days reminding some of them of the dark days of 2008 when Lehman Brothers collapsed.

“I curtailed the use of structured notes in my portfolio in part because of our concern about the banking system and the credit risk you’re taking,” said a buysider.

“I don’t think the current banking turmoil reflects a systemic crisis like in 2008. The risks are different today. Back then it was really systemic. It was created by mortgages without proper underwriting. That’s not the case now as it hasn’t been as widespread as it was back then. Still, you can’t help feeling the same anxious feeling. What’s happening is sort of taking you back to that time. There is a sense of deja-vu.”

Other solutions

For the sellsider, the crisis appears to be under control, at least for now.

“There was a sense of panic with Credit Suisse especially when some of their bondholders were hurt,” said the sellsider referring to the AT1 bonds, which were written down.

“Structured notes are more senior. Still, people were really nervous. But the quick response from the regulators worldwide was very effective in calming nerves. After the rescue, things went back to normal.”

One possible impact of the current banking jitters could be a surge in demand for structured products wrapped in assets that are not notes but funds regulated by the Investment Company Act of 1940, such as mutual funds, exchange-traded funds and unit investment trusts. For the sellsider, this trend is already unfolding.

“We’ve noticed a big inflow into 1940 Act products recently as a result of those credit risk fears,” he said.

“Structured investments that are not notes issued by banks are growing very fast. They’re benefiting a lot from this banking crisis. When you buy a structured ETF or a structured UIT, it’s not a bank issuing a note to raise money. You don’t have the credit risk. More importantly you don’t have the liquidity risk. A bank issuing a note offers liquidity only on a best offer basis. A fund under the 1940 Act is required to offer liquidity.”

So, whether investors are anxious about credit risk or illiquidity, a lot of their concerns are alleviated when they switch wrappers moving out of notes into funds, he said.

Agents this year through Friday have sold $17.75 billion in 3,468 deals, a 24% drop from last year’s $23.39 billion issued in 6,873 offerings.

The top agent last week was UBS with $57 million in 23 deals, or 30% of the total. It was followed by BofA Securities and JPMorgan. The No. 1 issuer was BofA Finance LLC with nine offerings totaling $40 million, a 21% share.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.