Issuance volume, deal count drops in first half of the year, the worst for equities since 1970

By Emma Trincal

New York, July 13 – The U.S. structured notes market generated $43.43 billion in the first half of the year, a 14% decline from $50.52 billion during the same period last year, according to data compiled by Prospect News.

More notable was the 42% drop in the number of deals from 15,108 to 8,702.

Many attribute the decline in the tally and deal count to the stock market, with the S&P 500 index entering bear market territory on June 13, according to Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.

“Enter the bear, exit the bull. We decidedly entered a bear market [in June], as higher inflation, higher interest rates and a slowing economy pushed the S&P 500 into official bear territory,” he said.

At the end of June, the S&P 500 index was down 22.4% from its last closing high of Jan. 3.

The S&P 500 posted its worst return for the first half of the year since 1970, Silverblatt said in a news release.

Deal count down

“The bear market certainly has an impact on issuance. But I’m not sure why we’re seeing such a huge decrease in the deal count,” said Matt Rosenberg, director at Halo Investing.

“Maybe it’s the impact of Barclays.”

Barclays Bank plc has suspended issuance of new notes since March because it sold more than its shelf capacity. The over-issuance has put its activity on hold until the bank delivers a rescission offer aimed at investors who purchased notes in over-capacity. No announcement related to this offer has been made at this time.

Barclays Bank plc was last year’s top issuer with $12.84 billion in 2,526 deals, averaging 210 deals per month, according to Prospect News.

“Even taking this into account doesn’t explain the gap,” he said.

“I guess deals don’t get called, that’s a big one. The stock market obviously is a major issue too.”

60/40 portfolio substitute

And yet, even in a bear market, investors would be justified to use structured notes, he said.

One of the benefits of structured notes is their use as an alternative to the traditional 60/40 strategy, which consists of building a portfolio allocating 60% to equities and 40% to bonds, he explained.

“With both stocks and bonds posting a negative performance, it seems like 2022 is the ugliest year for 60/40 portfolios,” he said.

“In previous down markets, their performance looked close to flat. But this year, it has been negative.

“I look at that as a great opportunity for alternative investments. How to mitigate the fixed-income exposure and the volatility in equities? Structured notes have an element of both and they provide some protection. You can maintain exposure to both. It bridges a gap.”

No cash

But this does not account for the big decline in structured notes issuance volume. For Rosenberg, one explanation may lie in liquidity.

“You need cash to invest. Deals don’t roll. There are no proceeds. If investors are sitting on equities, advisers won’t tell clients to pull out in this down market. And bonds come with liquidity issues.

“You have to have a liquidity event,” he said.

“The so-called crypto wealth, which would allow people to sit on cash is not really an exciting story anymore. Wealth has been destroyed. Same for some of the growth stocks. Given the inflation, people are more conservative. They stay put.”

As of June, crypto currencies have shed 87% of their total market cap after the peak of the 2017 bull run, according to cryptocurrency exchange platform Coinbase Global, Inc.

Commodities boom

One common thread seen in the first half has been the resurgence of non-equity underlying asset classes.

The most spectacular growth comes from commodities, whose volume climbed 155% to $700 million during this year’s first half from $275 million. The number of offerings increased from 27 last year to 75 during that time.

“The natural decay in futures has made those products less than perfect. But people are seeking inflation hedges and commodities are a great avenue for that,” said Rosenberg.

GS Finance Corp. priced two large commodities deals in June and February sized at $96.9 billion and $52.36 billion respectively, both tied to the Bloomberg Commodity index.

If this index was used for the top two deals (as well as others in smaller sizes), at least 47 offerings were linked to an equally-weighted basket of eight commodities. The series totaled $381 million.

The underlying basket was common to all offerings and consisted of West Texas Intermediate light sweet crude oil futures contracts, ICE Brent Crude futures contract, natural gas futures contract, corn futures contract, soybean futures contract, wheat futures contracts, copper and zinc.

Morgan Stanley Finance LLC priced the largest one of those basket-linked deals for $41.45 million at the end of April.

Most of those notes offered a floor of par.

Almost every issuer came out with this structure, including BofA Finance LLC, Citigroup Global Markets Holdings Inc., JPMorgan Chase Financial Co. LLC, UBS AG, London Branch and Credit Suisse AG, London Branch.

Small dollar bets

On a more anecdotal note, currency deals have begun to pop up very recently but in extremely tiny sizes.

On June 29, Citigroup Global Markets Holdings Inc. priced three $1.6 million digital short-term securities note offerings linked to the S&P 500 index and the U.S. dollar/Japanese yen exchange rate. Tenors varied between two and three months. Investors received a lower or higher digital payout depending on where the worst-performing asset closed in relation to the barrier.

“It’s sort of unique for registered notes. Typically, when I think of FX notes, I think of them as private placement centric in the U.S. market,” said Rosenberg.

The U.S. dollar has strengthened against major currencies while other currencies like the Japanese yen and the euro have been falling. The U.S. Dollar index is up 12.3% year to date as investors shift their investments into safer assets in a typical flight to quality.

Heavy bid on rates

Finally, rates-linked notes issuance has jumped during this year’s first half, up 84% to $1.134 billion from $615 million, according to data compiled by Prospect News.

“Given where rates are, issuers are able to structure better terms with shorter notes in the two-to-three-year space,” said Rosenberg.

“Interest rates are going up and the rate environment is volatile. People buy those rate-linked notes to get higher yields but also to diversify,” a sellsider said.

“The value of structured notes remains sensitive to interest rate moves but not as much as bonds. That’s a big advantage for income investors who use structured notes to somewhat hedge interest rate risk.”

Bearish sentiment

Meanwhile the tally for equity, which include single stocks, baskets of stocks and equity indexes has dropped 11% this year to $37.66 billion from $42.4 billion. The deal count is down 41% to 7,557 from 12,805.

“Clients are skittish about being in the stock market in general,” a financial adviser said.

“The notes that we purchased four or five years ago have done very well. All have been up massively except for the past six months.

“But we haven’t had anybody renew. When the notes come due, clients are not really jumping in to do another one despite the top performance we had.”

Biggest trades

The top two deals during the first six months of this year were hybrid products with derivatives and convertible features. Those so-called “cash-settled” notes, which are linked to a single stock showed very large sizes.

BofA Finance did the biggest one in May for $530.45 million with Merck & Co., Inc. used as the underlying.

Last month, JPMorgan followed suit with $387 million of cash-settled notes on Boeing Co.

The third largest offering was the typical 15-month Accelerated Return Notes on the S&P 500 index with three times leverage on the upside up to a cap and full downside exposure. It was a $140.02 million deal issued by Royal Bank of Canada in January and sold by BofA Securities.

Accelerated Return Notes remain the structure type generating the largest sizes.

© 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.