Structured products issuance in February kicks off with $581 million for week amid stock rally

By Emma Trincal

New York, Feb. 10 – Structured products issuance volume for the first week of February showed $581 million sold in 184 deals, according to preliminary data compiled by Prospect News. Figures are subject to upward revisions.

January ended on a strong note with $1.6 billion in 391 deals priced in the final week of the month, according to the latest update.

So far February is stronger than January, but the data remain preliminary.

“It’s only the beginning of the year. We don’t have a trend yet,” a sellsider said.

“January has been so insane. We had all kinds of disruptions especially with the Reddit traders betting against the shorts.”

He was referring to the short squeeze of videogame retailer GameStop and AMC Entertainment Holdings Inc. originating from users of social media website Reddit. Call buying was extreme, moving GameStop’s share price to a $483 peak on Jan. 28 from its $17.25 value in the beginning of the month, which caused drastic losses for hedge fund managers short the stock.

On that day some brokerages, including Robinhood Financial, halted the trading of GameStop and other targeted stocks due to excessive volume.

Uncertainty is back

“When people start ganging up to take down hedge funds and succeed, you have to wonder: shouldn’t I be sitting on the sidelines? This is too crazy,” the sellsider said.

“The market is bullish only because of the craziness of the speculators trading on social media.

“It’s a mob storming a stock. We had a lot of mobs in January.”

This sellsider said the volatility created by the unprecedented volume may have an impact on structured notes issuance looking forward if similar events reoccur. But it remains to be seen how and to which degree structured notes sales may be affected by the new phenomenon.

“There’s still a lot of uncertainty out there. When everybody trades the same way and you don’t have the other side of the market, it’s scary.”

But this sellsider is not pessimistic, arguing that structured products still work in most market environments.

“I think it will come back. People are just cautious. They think let’s not jump in at this point. Let’s see how things play out because crazy stuff can happen.

“I think it makes sense because if you’re on the wrong side of the mob, there’s nothing you can do except get out.

“January was just a bad month,” the sellsider said.

Rallying

After the declines of the previous week due to the Reddit-induced trading, the stock market last week took a quite different turn with investors optimistic about a new stimulus as well as better-than-expected earnings. On the coronavirus front a pending approval for a third vaccine developed by Johnson & Johnson, which only requires one dose in addition to progresses in vaccination overall, were also encouraging, helping the indexes to hit new record highs.

The S&P 500 index surged 4.6% on the week while the Nasdaq jumped 6% and the Russell, 7.7%.

The S&P 500 is up 3.6% for the year.

Indexes

Indexes made a comeback last week with 80% of total issuance volume in this asset class against 18% for stocks and 2% for ETFs.

This coincided with a drop in volatility after the sharp surge of the previous week. From Jan. 27 amid the worst of the short squeeze to last Friday, the CBOE Volatility index dropped more than 44%.

Investors and structured notes buyers returned to normal, sources said.

Autocallables remained the main structure: 44% of the notional came from autocallable contingent coupon (Phoenix type) and 15% from snowballs, the latest representing a notable increase from the average. Leverage notes with no downside protection accounted for 12% of the total while leverage with barriers or buffers made for a meager 3%.

“Snowballs offer higher payouts because the threshold is higher. The good thing is you can catch up the premium later on. But you can also wind up with nothing at the end if you keep missing the call,” the sellsider said.

Leverage

The decline of leverage is a constant trend. But last week showed a greater than usual divergence between leverage with and without protection. Part of the problem of course is the cost of barriers and buffers, requiring caps for financing, which may not appeal to investors especially in a bull market.

“For index-linked products, volatility has come back down. Caps don’t look as attractive as they used to be. Uncapped, it looks worse if you can even price it at all. You see decay in the terms of plain-vanilla index-linked notes,” a trader said.

For the year to date, autocallable notes continued to make headway with a 65.3% market share for Phoenix-type and 3.75% for snowballs, a total of nearly 70% of the market. Leverage on the other hand was only 16% of the total. The remaining market shares represent miscellaneous categories of products.

“You can get buffered products with ETFs and UITs now. I think that’s part of the reason why leverage is drying up,” the sellsider said.

“The future of structured notes will be more and more dominated by income plays. It’s already happening right now. Asset allocation products like enhanced return notes will migrate into the 1940 Act space.”

He was referring to some of the investment vehicles regulated by the Investment Company Act of 1940, which govern mutual funds, hedge funds, exchange-traded funds and unit investment trusts.

Income motivation

Single stock underliers are up 22% this year compared to a year ago. Autocallable products have also increased in volume albeit at a slower rate of 4.5%.

The growth in autocallables and their stock underliers has the same root, sources said. They point out to the challenge of finding income in a low interest rates environment where the 10-year Treasury yields 1.14%.

In the inflationary market of the early 1980s’ the 10-year Treasury was yielding 15%.

“Rates are so low.... there’s no incentive to put money in the bank. It encourages all types of whacky behavior like buying annuities paying 3% for 20 years without realizing that eventually, interest rates are going to be 10% to 12%. People are making very poor investment decisions,” said a portfolio manager.

“Certain autocalls tied to stocks with crazy valuations like Tesla or even tech stocks are extremely risky. Just because the stock keeps going up, people assume the investment is safe. They’re blocking out the possibility they could lose money.”

Trailing 12-month

Issuance volume for the trailing 12 months showed a 24.6% increase to $70.5 billion between Feb. 6, 2020 and Feb. 5, 2021 from $56.6 billion during the previous 12 months, the data showed. The advance is so far the result of last year’s record high volume of more than $72 billion.

Top deals

Canadian Imperial Bank of Commerce priced $47.31 million of 18-month digital notes linked to the Russell 2000 index. If the index return is greater than or equal to negative 10%, the payout at maturity will be 15.15%. Otherwise, investors will lose 1.1111% for every 1% index decline beyond 10%.

CIBC World Markets Corp. is the agent.

Barclays Bank plc priced $46.83 million of three-year callable contingent yield notes with daily coupon observation linked to the worst performing of the Nasdaq-100 index, the Russell 2000 index and the S&P 500 index.

The annualized contingent coupon of 12.07% is paid based on an American coupon barrier of 65%.

The notes will be callable on any quarterly observation date. The barrier at maturity observed point to point is 55% of the initial price. UBS is the agent.

UBS also priced on the behalf of Bank of Nova Scotia a $38.88 million issue of three-year autocallable contingent coupon notes linked to the S&P 500 index. The annual contingent rate is 7.08% based on a 70% coupon barrier observed quarterly. The notes are automatically called after six months if the index is at or above its initial price.

Index-linked notes prevailed last week, including single index deals. For instance, there were GS Finance Corp.’s $38.35 million – a leveraged note tied to the Russell 2000 – and GS Finance’s $37.96 million of a digital notes on the S&P 500 index. JPMorgan Chase Financial Co. LLC priced another digital deal for $34.92 million on the S&P 500 index.

BofA closing

The previous week closing the month of January saw large block trades which were reported after Prospect News’ deadline. The biggest one was GS Finance’s equity-linked notes tied to AbbVie Inc., which priced for $71.7 million. During that last week of January, BofA Securities captured 38.3% of the market, according to revised figures.

For last week, UBS topped as agent with 166 offerings totaling $175 million, or 30.1% of the total sold.

It was followed by JPMorgan and Goldman Sachs.

Bank of Nova Scotia was the No. 1 issuer with $106 million in six deals, an 18.2% share.

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