Structured products tally down 10.6% year to date; ETF-linked notes up 34%

By Emma Trincal

New York, July 12 – Structured products agents sold $44.21 billion this year through July 7, a 10.6% decline from $49.43 billion priced during the same time last year, according to preliminary data compiled by Prospect News.

The deal count dropped to 9,946 from 15,302.

Updated data for last month showed $6.45 billion in 1,305 deals, placing June just above April but below the top two months of March ($8.76 billion) and May ($7.96 billion). In between, February and January placed third and fourth, respectively.

Last week’s data was incomplete due to the Fourth of July holiday, which fell on a Tuesday, leading many to take the Monday off.

Last week’s top deal was Citigroup Global Markets Holdings Inc.’s $37.58 million of 13-month basket-linked notes linked to an unequally weighted basket of five foreign indexes representing the euro zone, Japan, the U.K., Switzerland and Australia. The payout was 1.71 times the basket return. There was no upside cap and no downside protection.

Bullish sentiment

The year to date is showing asset classes and structure trends that reflect a very different equity market than 2022.

Equity prices have rallied, and volatility has been driven to lows not seen since the beginning of the decade while interest rates have been climbing due to the Federal Reserve’s tightening.

“We’re definitely in a different environment than last year,” said Brady Beals, director, sales and product origination at Luma Financial Technologies.

The S&P 500 index is up nearly 17% for the year. During the same time in 2022, it was down 21%.

“People are generally more bullish, but they perceive a heightened risk. They want protection against a black swan event but also more upside,” said Beals.

Leveraged note issuance has declined this year. For Beals, this can partly be explained by investors’ sentiment.

“There is still interest for growth but it’s a mixed picture. People want uncapped upside. They don’t really care about a 70% barrier. They’re more worried about being down 50%. Some of them will give up some of the protection for more upside. We’ve seem more clients rejecting caps,” he said.

Put-to-call ratio

One sure indicator of the market’s bullishness is the current put-to-call ratio of 0.74, according to CBOE Daily Markets statistics. The ratio of equity put options relative to equity call options is “historically low,” said Steven Jon Kaplan, founder and portfolio manager at True Contrarian Investments.

“Call options are very popular, and their price is extremely high compared to puts. It’s some sort of a historical shift. It definitely reflects complacency in the market,” he said.

In the midst of the Covid bear market on March 9, 2020, the put-call ratio was 1.83, a sign that risk aversion prevailed.

Flattish PPN issuance

Perhaps market sentiment explains why principal-protected notes have only grown modestly this year despite the much more favorable interest rates environment.

Participation-notes with full principal protection have seen their notional increase by only 2.43% in 2023 to $363 million from $355 million a year ago, according to the data through July 7.

“I’m not seeing great principal-protected notes, and that’s odd,” said Andrew Valentine Pool, main trader at Regatta Research & Money Management.

“I thought I’d see more PPNs since rates are now so much higher. Early last year, Fed Fund rates were close to zero. Now they’re above 5%. It goes against what you would normally expect.”

PPN stand for “principal-protected note.”

Competitive solutions, taxes

Besides the bull market factor, another reason for the muted growth of PPNs this year is the abundance of other options such as traditional certificates of deposits, short-term Treasuries and other investments delivered in different wrappers, Beals said.

“Contingent income autocalls are not easily replicated in other markets. So those products are still thriving,” said Beals.

“But you can find a lot of investments similar to PPNs in fixed annuities or structured ETFs. PPNs face a lot of competition including from traditional fixed-income.”

“Also, the OID tax treatment that comes with PPNs is not great for a lot of people.”

The original issue discount (OID) is the difference between par and the discounted price of the zero-coupon bond used to price the principal-protection. The discount generally implies an ordinary income tax treatment, which is not as favorable as the taxation of long-term capital gains.

Innovation

“There’s a lot more competition out there. That’s one of the reasons you’re seeing more creativity in payouts. We’re not doing as many 70/70 worst-of anymore. You’re seeing new kinds of barriers, step down autocalls, catapults and many other new things,” said Beals.

The so-called “catapults,” offer uncapped leveraged upside at maturity with significant downside protection if a one-time call has not been triggered. Originally, those structures provided full principal-protection. But they have evolved as buffered notes for the most part.

Issuers have also continued to use volatility control proprietary indexes to generate principal-protection. Those underliers include the Barclays Trailblazer Sectors 5; the Citi Dynamic Asset Selector 5 Excess Return index; the Goldman Sachs Momentum Builder Focus ER; and the J.P. Morgan Efficiente Plus among others.

“Issuers had to develop those prop indices when interest rates were low. While rates are much higher now, people have become more comfortable with those low vol. indices. They’re sort of used to them. So, we still see plenty of those deals,” said Beals.

Another typical technique consists of extending the maturity in order to compound enough dividends to price the full protection. Depending on the index, such structures can come at the cost of a low cap and one-to-one upside participation.

Short-term buffers

The extreme inversion of the yield curve has produced some benefits, for instance the pricing of short-dated notes with sizable buffers.

Examples include UBS AG, London Branch selling last week $4.78 million of 14-month notes linked to the MSCI EAFE index paying 1.5 times the index gain up to a 17.5% cap and delivering a 20% geared buffer on the downside.

HSBC USA Inc. offers another recent example with $339,000 of 15-month notes tied to the S&P 500 index with 1.5x the gain capped at 13.5% and a 15% regular buffer.

“Growth note pricing is driven by volatility, but volatility isn’t the only factor,” said Beals.

“A lot of these deals are powered by the rate environment. The shape of the curve has enabled pretty good terms on the short end.

“It’s definitely a rate thing.”

ETF explosion

On the asset class side, ETFs are the clear winners among equity products. Notes tied to ETFs have increased in volume by 34% this year to $3.82 billion from $2.85 billion.

Bank of Nova Scotia in May priced the top ETF issue with $48.24 million of 14-month notes linked to the Energy Select Sector SPDR fund. BofA Securities, Inc. was the underwriter.

The payout was par plus triple any ETF gain, up to a maximum return of 34.66% and one-to-one the downside.

“It makes sense. The energy sector is very attractive. It’s been beaten up, so you get better entry points and better terms. The risk is worth the reward,” said Pool.

Invesco S&P 500 Equal Weight ETF has been a very popular ETF so far this year amounting to $237 million in 31 deals.

“People realize that major indices are heavily weighted toward certain sectors, in particular tech. RSP wasn’t getting priced last year but we’re seeing a lot of it this year. There’s definitely demand for it,” said Beals referring to the fund’s ticker.

Sector plays aside from energy and some deals on gold miners have seen limited issuance. One exception was the use of the SPDR S&P Regional Banking ETF after the regional bank crisis in March.

ETFs tracking the broad-based indexes such as the SPDR S&P 500 ETF Trust, the Invesco QQQ Trust, Series 1 (for the Nasdaq) and the SPDR Dow Jones industrial average ETF Trust have surged. Their growth contributed to the expansion of the ETF asset class.

The top agent in June was Morgan Stanley with $1.48 billion in 195 deals, or 22.9% of the total.

It was followed by UBS and JPMorgan.

The No. 1 issuer was JPMorgan Chase Financial Co. LLC with 235 offerings totaling $927 million, a 14.4% share.

© 2015 Prospect News.
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