Structured notes buyers sit on sidelines amid stock market sell-off, source says

By Emma Trincal

New York, May 11 – Structured products issuers priced $2.75 billion in the final week of April and $337 million to kick off the month of May, according to updated data compiled by Prospect News. Last week’s figures remain preliminary, but sources noted a slowdown amid a continued sell-off in the equity markets since the beginning of the year.

Issuance volume dropped 14.4% this year through May 6 to $29.58 billion from $34.56 billion last year. The tally for deals fell by 43% to 5,860 from 10,279.

With the Federal Reserve hiking interest rates 50 basis points on May 4, volatility surged in the second half of last week, the VIX jumping above 35 on Friday. The market rallied on Wednesday after Fed chair Jerome Powell pleased investors in ruling out a 75 bps increase in the near future while the 50 bps hike came as no surprise. But stocks plunged the following day on fears that the Fed’s efforts to cool inflation may lead to a recession.

The S&P 500 index is down 15% year to date.

Turbulent market

“The correlation this year between the Fed’s hawkish shift and weak equity markets is seemingly undeniable,” said Paul Hoffmeister, chief economist at Camelot Event Driven Advisors, in a note.

The impact of the stock market correction on structured notes sales is not as easy to pin down, although more sources are beginning to see a correlation between lower stock prices and thinner flows.

“Things are slowing down,” a market participant said.

“I’m not seeing a lot of activity. People used to buy on the dip, but this particular drawdown is not really encouraging them to put money to work. The negative sentiment seems to prevail. It looks like investors are increasingly sitting on the sidelines.

“However, it’s starting to pick up a little. Some investors are beginning to hope for a rebound. If that’s the case, if more people regain confidence, we could see more volume,” he said.

Five to three

This market participant said he is seeing shorter durations.

“Some three-years are pricing better than the five-years. That’s unusual,” he said.

“Normally you would expect better terms over a longer tenor. But I’ve noticed, especially from one issuer, that terms are better on three-years.”

He attributed this phenomenon to hedging costs.

“My guess is that uncertainty is really having an impact all across the board. Issuers are always looking ahead when pricing. They don’t just analyze current conditions. They have expectations regarding the future whether you’re talking about options prices, the volatility term structure, the correlations, interest rates and so on.

“They look at the forwards to estimate how much it’s going to cost them to hedge a deal.

“If they feel that five years out, conditions are too murky and that their hedge is too costly, they may want to shorten the tenor. They try to incite you to come over to the three-year space and they end up giving you better terms for that,” he said.

Such reasoning may not be valid for all issuers and all types of products, he said.

Autocallables

Last week saw a return to autocallable income notes making for two-thirds of the issuance volume. Leverage represented a very small fraction of the total with only four deals totaling $25 million, but the data remains subject to changes. On the asset class side, indexes and single stocks competed for market shares making for 39% and 36.5% of the total, respectively.

Despite more elevated volatility levels, some income notes were designed using a variety of tools to boost the terms.

One example was Citigroup Global Markets Holdings Inc.’s $55.48 million of trigger callable contingent yield notes with daily coupon observation due Feb. 6, 2025 linked to the Nasdaq-100 index, the Dow Jones industrial average and the Russell 2000 index. The notes will pay a contingent quarterly coupon at an annualized rate of 13.61% based on a daily observation barrier of 70%. UBS is the agent.

The market participant noted that the issuer was able to price a double-digit coupon with a 50% barrier at maturity.

“You really have the whole gamut...the worst-of, the issuer call, the American coupon barrier,” he said.

“Broadly speaking, pricing doesn’t really look so good.

“Issuers keep on doing those worst-of because they still need to squeeze some juice. But there is less and less to squeeze. Correlations are so high right now... indices are all falling in sync. Banks are not getting as much premium out of the dispersion. Higher correlations offset some of the benefits of increased volatility.”

Big floater

The surprise last week was a large interest-rate product offering from Canadian Imperial Bank of Commerce. The issuer priced $61.35 million of three-year floating-rate notes linked to the two-year U.S. Dollar SOFR ICE swap rate.

The interest rate is the two-year ICE rate plus 10 basis points, subject to a floor of 3%. The payout at maturity will be par.

CIBC World Markets Corp. is the agent.

“That to me is definitely a large institutional trade,” he said.

“I like the structure. It’s very straightforward.

“My only pushback is that our advisers would have a hard time explaining the underlying rate. No one in retail is familiar with SOFR, let alone the two-year U.S. Dollar SOFR ICE swap rate. That’s my hesitation.”

Floating-rate notes are gaining traction, a sellsider said.

“There are a lot of money managers in the fixed income space who want to reduce duration risk in their portfolio.

“This type of deal is pretty straightforward. It’s a good way to keep the value of the notes close to par when interest rates go up,” the sellsider said.

Amazon, growth names

Last week’s largest single-stock deal came from BofA Finance LLC in $25 million of leveraged notes. The issuer used its “Accelerated Return” structure, usually referencing the S&P 500 index, to apply it to the price of Amazon.com, Inc. The payout is three-times the upside up to a 33% cap and no downside protection.

“It’s one to one on the downside, but the stock is already down 37% this year,” the market participant said.

“That’s a note for people who don’t expect much more downside. After all, it’s Amazon, an e-commerce giant and global leader in the space. I sort of like this note with the price as depressed as it is.”

Overall, however, fewer notes were tied on growth stocks, given the severe pullback in the technology sector. The Nasdaq-100 index was close to 30% below its November high as of the Wednesday mid-afternoon session.

“There will be fewer growth underlyings, that would be my expectation,” the sellsider said.

“People are pulling back from these aggressive underlyings in the short term at least.

“A lot of trades have gone under water. Until that gets resolved, it will be difficult to find advisers interested in doing trades on momentum names.”

“You can get really good pricing on more blue-chip names or indices. You don’t need the tech names as much to juice up the return.”

End of April

Some recently reported offerings from the week prior to last week included UBS AG, London Branch’s $38.03 million of two-year digital notes linked to a basket of non-U.S. equity indexes. The payout was the greater of 29% or the basket gain with full downside exposure.

Finally, Morgan Stanley Finance LLC continued to price short-dated commodities notes with one-to-one uncapped exposure on the upside and full principal protection.

Specifically, the agent sold two deals for $41.45 million and $36.7 million, respectively. The underlying basket consists of an equally weighted basket of eight commodities – the West Texas Intermediate light sweet crude oil futures, Brent crude oil futures, natural gas futures, corn futures, soybean futures, wheat futures, the grade A copper spot price and the special high-grade zinc spot price. UBS was the dealer on the second deal.

“I’ve seen those deals. Citi and Goldman Sachs are starting to do their own commodity notes too. Once a bank starts creating something and the other issuers get wind of it, it doesn’t take long before more of the same comes out,” the sellsider said.

The top agent last week was JPMorgan with $117 million in 11 deals, or 34.8% of the total.

It was followed by UBS and CIBC.

The No. 1 issuer was Citigroup Global Markets Holdings with four offerings totaling $77 million, a 23% share.

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