Year on track to be one of the best, if not the top year, for sales of U.S. structured notes

By Emma Trincal

New York, Aug. 18 – This year could be a record year, or even the best, for structured products sales if one can predict issuance volume for the next four and half months.

Agents priced $52.39 billion through Aug. 13 in 14,251 offerings, a 21.4% jump compared to last year’s tally of $43.5 billion sold in 13,188 deals during the same timeframe, according to data compiled by Prospect News.

With $72.7 billion, last year was the top year ever since Prospect News began collecting data in 2004.

Volatility

The healthy flows seen so far this year are puzzling to some analysts and buysiders, who deplore the lack of diversity in the products and the lower quality of the structures.

“I really wonder why the terms are changing for the worse,” said a buysider.

“We’re told that it’s because of the market in general. The VIX is too low; that’s the typical explanation. But the VIX in the past, except in March last year, has often been lower than what it is now.”

The VIX index was trading at 23.8 on Wednesday but was as low as 18.42 on Friday.

“The VIX was lower in the past four years. It even dropped below 10 at some point. And yet we were getting great terms four years ago.”

Risk control

A portfolio manager said one possible reason behind the deteriorating terms may be banks becoming skittish as they need to hedge their risk in a toppish market.

“Banks are getting concerned about their exposure to the indices. They don’t want more of it. That’s one of the reasons terms are getting worse and worse,” he said.

This preoccupation with risk exposure is more palpable with autocallables, he added.

“If we have a big run up, so many of those notes will get called at the same time. They would have to come up with all the capital at once.

“Banks are trying to control their own risk.”

Autocall growth

This has not stopped issuers from offering an increasing number of autocalls. Early redemptions in a rising market and continued demand for yield enhancement are the main contributors to this continuous trend.

A total of $33.3 billion worth of autocallable contingent coupon notes, callable contingent yield notes and snowballs have been issued this year. This is close to two-thirds of this year’s volume, and it’s a 52.6% increase from last year’s volume.

“Autocalls get called and bought because structured notes are the only decent source of yield right now,” the portfolio manager said.

“But there is so much liquidity in the system. We’re talking $6 trillion in federal spending. That’s a lot of capital around. Banks don’t have to pay anything for your capital.”

The treasuries at the banks are setting some limits, he added.

“The funding budget to put together the notes is shrinking. That’s why terms are coming down.”

A changing industry

A key to understand what is happening to individual deal quality is to look at where the industry is today compared to where it was 15 to 20 years ago in the United States, said Rick Cabanes, chief executive and founder of CleverAlpha Asset Management.

“In the beginning it was new and exciting, and the desks were willing to take more risk and print tighter, innovative deals to build business lines,” he said.

“But over the past few years, many of the desks have been decimated by competition, less balance sheet, high hurdle rates to perform and of course low interest rates,” he added.

Low interest rates have generated excess liquidity, reducing banks’ need for funding, which in turn resulted in tighter funding levels.

“The products don't have the fuel to embed optionality,” he said.

Other factors related to the overall distribution system have also been at play.

“The expansion of electronic platforms competing with the wirehouses has also changed the nature of the business,” he said.

“Profitability no longer comes from a single Cusip, but rather from a product pipeline that sells within a distribution channel.

“The offerings are concentrated around a limited and specific type of product and distribution channel.”

Market still up

Agents priced $220 million in 110 deals in the week ended Friday, according to preliminary data compiled by Prospect News. Those figures will be revised upward. Updated data from the previous week, which was the first of the month, showed $1.338 billion in 190 deals, which signals that distribution has definitely moved toward a weekly calendar rather than the traditional monthly cycle taking place during the final week of any given month.

Sentiment in the equity market remained bullish as evidenced last week.

Despite the spread of the Covid-19 Delta variant and the highest inflation rate since 2008, the stock market continued to push higher with the S&P 500 index reaching a new record close. Strong earnings and an infrastructure bill helped the market shake off negative news. The S&P 500 index is up 18% so far this year.

But a growing number of market participants are predicting a correction.

“No matter what’s going on in the world, it seems like every day is a new all-time high,” said Cabanes.

“Sooner or later, the market is going to turn, leaving bag holders in the largest notional part of the market: the non-principal protected equity structures.”

Top deals

As always, the proportion of autocalls dominated last week. Sixty eight percent of total sales originated from autocalls versus 20% for leverage, according to the data.

On the novelty side, one issuer used a new index in a note for the first time.

JPMorgan Chase Financial Co. LLC sold $3.58 million of autocallable contingent interest notes due Aug. 13, 2026 linked to the MerQube US Tech+ Vol Advantage index.

The index, which was developed by MerQube in coordination with J.P. Morgan Securities LLC, was launched on June 22.

The rules-based index provides a dynamic exposure to an unfunded rolling position in E-Mini Nasdaq-100 futures while targeting a level of implied volatility.

The notes pay a contingent monthly interest of 13.05% per annum if the index closes at or above its 70% interest barrier. The notes are automatically callable after one year.

The asset class mix for underliers was more diverse than usual with 48% going to equity indexes and 35% to stocks.

The top stock deals were based on single name, most of which featuring issuer calls.

Royal Bank of Canada priced $11.05 million of two-year issuer callable notes on Square, Inc. A 10.25% annualized coupon is paid quarterly if the stock closes above its 68.5% coupon barrier, which is also the final trigger level. The autocall feature begins six months after the trade date.

Citigroup Global Markets Holdings Inc. priced $9.1 million of one-year callable contingent coupon notes tied to solar energy stock Enphase Energy, Inc. paying a contingent coupon of 13.05% per year based on a 50% barrier.

The top agent last week was UBS with $78 million in 78 deals, or 35.3% of the total. It was followed by Goldman Sachs and Citigroup.

Citigroup Global Markets Holdings was the No. 1 issuer with 23.5% of the notional in seven deals totaling $52 million.

© 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.