Structured products tally $478 million for week as low vol. continues to challenge optics on terms

By Emma Trincal

New York, July 26 – Agents priced $478 million of structured products in 108 deals last week as the equity market continued to rally, according to preliminary data compiled by Prospect News.

Volatility remained muted. The VIX index closed the week at 13.60.

But benchmarks showed divergences between blue-chip and tech stocks. The Nasdaq rose 0.6% for the week while the Dow Jones industrial average climbed 2.1%.

With this year’s bull run, advisers are finding it difficult to get attractive terms on their notes.

Coupons, caps, leverage multiples have trended lower for equity-linked notes, some advisers complained in interviews with Prospect News. Issuer calls have been increasingly used in an effort to boost coupons but are not necessarily popular, they said, especially when they can be triggered as early as a month from issuance.

“On an absolute basis, volatility is way down. The price of the options is lower. Selling options can’t capture as much premium as it used to. Whether people sell covered calls or buy autocalls for the coupon, they don’t make as much money as they used to when volatility was at more decent levels,” a market participant said.

End of an era

A buysider cited a recent report from Michael Smolyansky, a Federal Reserve economist, titled “End of an era,” to explain why equity gains cannot and will not always be attractive.

According to the paper, stock returns over the last three decades have been high because of consistent declines in interest rates and corporate tax rates. With both rates and taxes expected to rise in the future, corporate profit growth will slow. The paper concludes that equity investors may only get 2% in real annualized returns.

“If we’re successful in taming inflation back to 2%, you’re getting a 4% annual return going forward. Everybody’s retirement projections are going to be wrong,” he said.

Structuring matters

Such bleak predictions for equity market returns make the case for structured notes, he said.

“If you can apply a 2x multiple to that 4%, we go back to 8%. Structured notes to me are a no-brainer.

“I don’t understand why advisers don’t use them more already. They can’t get their hands or minds around it I guess. They’re missing opportunities for better returns,” he said.

A market sell-off could bring back coupons and caps to more alluring levels, he noted. But advisers don’t get involved in market timing. Still, volatility itself can spike over short periods of time.

“We could still see a lot of volatility and find structures that offer opportunities. You can always grab a good note,” he said.

A bond trader said that he did not understand why some advisers demand high returns in a low-risk environment.

“When the risk is low so are the coupons, so are the caps,” he said.

“The market doesn’t perceive much risk right now. The market is not concerned about inflation. We pretty much know what the Fed is going to do. It’s coming to the end of raising rates.”

As expected, the Fed on Wednesday increased interest rates by a 25 basis points.

“If you want low risk, go and buy rate products,” he said.

Bid on rates

Investors appeared to have followed the advice.

Issuance volume of interest rate-linked notes has nearly tripled this year to $3.6 billion from $1.25 billion a year ago, according to the data.

The top two deals last week were 13-month fixed-to-floaters issues linked to the one-year U.S. Dollar SOFR ICE swap rate. One for $60 million came from JPMorgan Chase Financial Co. LLC.

For the first four months, the notes pay a monthly fixed coupon of 7% per year, then the floating rate is the one-year U.S. Dollar SOFR ICE swap rate plus 35 basis points, subject to a floor of 1% per annum.

Bank of America Corp. issued the second one for $50 million paying a 7% fixed annualized coupon for the first three months with a 40 bps spread for the variable rate.

The bond trader was not impressed.

“If I’m going to buy one-year, I’m going to buy a one-year Treasury. I’m not going to burn a lot of calories to put a structure for one year,” the bond trader said.

But he liked the product type.

“Fixed-to-floating rate notes make sense, a lot of sense. You’re going to get a fixed coupon and after that you’ll float. You’ll float on CPI or on SOFR,” he said.

But rather than a short maturity, he would opt for a five-year term with a 6% fixed rate on the first year and 75 bps to 100 bps over the underlying rate for the floater.

“Rates are going to come down for the next year as the Fed will pause and start cutting rates.

“At some point yields on the front end will come down and yields will rise on the back end. That’s how the economy functions and that’s what it is 97% of the time.”

Such scenario offers great opportunities to investors in fixed-to-floating rate notes as well as steepeners, he said.

Stretching for yield

The buysider suggested a few options to boost yields on equity-linked notes.

“One simple way is to add a little bit more duration. I do that all the time,” he said.

This buysider also uses decrement indexes.

He recently bought a note from JPMorgan tied to the MerQube US Tech+ Vol Advantage index giving him exposure to futures contracts on the Nasdaq-100.

“These decrement indices can really help when volatility is low,” he said.

Based on an implied volatility target, the exposure to the contracts, if volatility is low, can be leveraged up to 500%.

“The leverage is so high, it will more than offset this 6% decrement over a certain period of time,” he said.

The decrement is a 6% per annum daily deduction from the index return, which is often described as a synthetic dividend. Instead of giving up a variable dividend yield, investors “lose” a fixed percentage amount.

Blue chip autocalls

Another way to boost coupons is to use riskier underliers such as single stocks or sector ETFs.

Morgan Stanley Finance LLC priced last week $20 million of one-year contingent income buffered autocallables on Microsoft Corp. The structure offers a 12.65% coupon based on an 80% barrier and a 20% geared buffer on the downside.

This issuer did another Microsoft autocall the same day for $10 million. Coupon barrier and downside thresholds were struck at 85%. The notes paid a 15.05% contingent coupon, and the geared buffer was 15%.

“Buying autocalls on very solid companies like Microsoft, Apple and Amazon makes sense,” the bond trader said.

“If you’re long Apple or Microsoft, you may not want to sell it. Getting into an autocall will mitigate your risk while giving you some return. It’s a good way to avoid selling your winners.”

AI excitement

Not all stocks used in notes were well-established companies. A little-known name – C3.ai, Inc. – has been used twice this month by Barclays Bank plc in $1 million deals with full principal protection. The company produces artificial intelligence software.

“There’s a lot of hype around AI. We should understand it before we get all excited about it. Most people use the stock market like it’s a big casino. They would bet on anything,” the bond trader said.

This “anything,” he said, might include stocks with promising hints. C3.ai trades under the ticker “AI.”

C3.ai, has only been used five times in structured notes, twice this year and three times in 2021.

Bid on ETFs

ETF-linked notes were in favor last week, making for 16% of total sales with $76 million. On average for the year their market share has been less than 9%.

Funds tracking broadly diversified indexes continued to be priced such as BofA Finance LLC’s $22.85 million of 15-month 9% trigger callable yield notes linked to the iShares Russell 2000 ETF and the SPDR S&P MidCap 400 ETF.

But investors bought more sector ETF underliers than usual.

JPMorgan Chase Financial priced $20 million of two-year autocallables linked to the SPDR S&P Oil & Gas Exploration & Production ETF.

The notes pay a contingent quarterly coupon at the rate of 14.5% per year based on a 60% coupon barrier. Separately, Citigroup Global Markets Holdings Inc. sold $10 million of one-year contingent income autocalls linked to the SPDR S&P Biotech ETF. The 15.2% contingent coupon with memory was based on an 85% barrier. The note offered a 15% geared buffer at maturity.

The top agent last week was JPMorgan with 19 deals totaling $105 million, or 22% of the total. It was followed by UBS and BofA Securities.

The No. 1 issuer was JPMorgan Chase Financial with $72 million brought to market in 20 deals, a 15% share.

Issuance volume for the year through July 21 is down 6.13% to $48.39 billion from $51.55 billion, according to the preliminary data. The deal count dropped 31% to 11,106 from 15,990.

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