Structured products issuance $345 million for week; action revolves around the Fed

By Emma Trincal

New York, Nov. 9 – The tally for last week’s structured notes sales was $345 million in 34 deals in a busy roller-coaster market once again centered on the Federal Reserve. The updated tally for the previous week closing the month of October was $1.79 billion in 321 deals, according to data compiled by Prospect News. Last week’s figures are preliminary.

Wednesday’s Federal Open Market Committee rocked the market as the Fed delivered a 75 basis point rate hike for the fourth time. Stocks first tumbled after the decision, then jumped after an announcement giving hope for a pause. The hopes were cut short when Fed chair Jerome Powell reiterated his determination to knock down inflation by moving forward with future rate hikes.

A stronger-than-expected October job report on Friday put some additional pressure on stocks sending the message that the Fed was not about to pause any time soon.

The S&P 500 index fell 3.3% on the week. The Nasdaq lost 5.6%.

From pivot to reality

“The Fed is really this 500-pound gorilla,” said Steve Sosnick, Interactive Brokers’ chief strategist.

“The raw material of the market is money and really, the Fed controls the cost of money and the availability of money. If they’re going to make money more expensive by raising rates and less available with quantitative tightening, that has a negative impact on the market.”

The fear of an ensuing recession has been driving this year’s stock market pullback.

“Everything has to revolve around the Fed. I always tell investors don’t fight the Fed. It has worked brilliantly for 14 years when the Fed was relentlessly accommodative. You had some brief hiccups, but the central bank could reverse course because inflation was not problematic. Now the Fed is raising rates and they have not indicated that they’re about to stop. Instead, they said they need to keep going. They have to fight inflation.”

The market however has had the tendency to rally and drop abruptly based on expectations ranging from “pivot hopes” to disappointment.

“The market keeps on hoping that the Fed will reverse course. It’s understandable. The market wants to go up. It’s human nature. If you’re not optimistic, you’re not investing. But there are no signs that the Fed is about to give up. We went from ‘pivot’ to ‘pause’ and from ‘pause’ to ‘slowing the pace’. Each time, the hopes get more meager,” he said.

Low-risk products

Meanwhile, interest rates especially on the short end of the curve have increased, attracting a new brand of conservative investors. The way it may affect appetite for structured notes is debatable. It depends on clients’ profiles and risk tolerance.

“We find more and more good returns on low- or no-risk investments. Now, you can get a three-year CD paying 5%,” said Mark Dueholm, chief fixed-income trader at Landolt Securities, whose clients are defensive investors.

“There are a lot of people who are very happy with a 5% return.

The increased volatility has helped issuers price notes on the S&P 500 index alone, making worst-of payouts less necessary, hence less visible, he said.

“You can now do deals on the S&P and still get principal-protection without going too far in duration, something that was not even conceivable a year ago,” he said.

This helps explain why investors are moving away from riskier structures, focusing on autocalls, leveraged and digital products with downside protection, ruling out unprotected structures or riskier asset classes such as commodities, foreign equity and even rates in non-plain-vanilla structures.

There are some exceptions, however, but the product needs to get investors’ attention. Last week, Toronto-Dominion Bank priced $45.13 million of 15-month leveraged notes on the Euro Stoxx Banks index paying 4x the index gain, up to a 48.92% cap. Goldman Sachs was the agent.

Steepeners blues

The distribution of structures and asset classes last week showed little diversification.

The supply was 98% equities, exceeding the 87% year-to-date average. Within equities, indexes overpowered single stocks and ETFs. Commodities were represented by a small $2.2 million deal from JPMorgan Chase Financial Co. LLC on Brent Crude Oil Futures.

Interest-rates-linked notes with optionality and underliers other than the SOFR were not seen, according to the preliminary data.

Dueholm offered an explanation about the rarefication of structured products on rates.

“A huge amount of deals was tied to a bet on a steeper yield curve. With the yield curve inversion, that trade blew off. People lost the appetite for steepeners or non-inversion notes,” he said.

Steepeners pay a multiplier on the spread between two rates at different points on the curve.

Non-inversion notes offer a binary outcome: investors get either 0% or a fixed return.

“With a spread of zero, you get zero in either structure,” he said.

Some issuers are trying to make those products more marketable, for instance in raising the initial fixed rates (teaser rates) or by extending the teaser rate period, he said.

“I’ve seen a deal with an 11% teaser payable for four years,” he said.

He was referring to Citigroup Global Markets Holdings Inc.’s 20-year callable fixed to float SOFR CMS spread range accrual notes on the S&P 500 index set to price Nov. 15.

CIBC’s $127 million

Autocalls were surprisingly under-represented last week making for 13% of the total. Digital products were by far the big winner catching 54% of the shares with eight offerings totaling $186 million.

Most of those digitals were “in-the-money,” which means investors get paid above a strike situated at a barrier or buffer level. A notable example was Canadian Imperial Bank of Commerce’s $126.84 million of two-year digital notes linked to the S&P 500 index, which was last week’s top offering.

If the index finishes at or above its 80% geared buffer level, the payout at maturity will be par plus 19.75%.

CIBC World Markets Corp. is the agent.

“Personally, I think that 20% is not enough for a two-year, even if it’s a 20% buffer,” said Dueholm.

“The market can definitely go down more than 20%. An autocall paying a fixed or contingent coupon makes a lot more sense to me.”

Two digitals

Two large digital offerings also hit the market during the previous week. GS Finance Corp. priced $36.87 million of one-year notes on the S&P 500 index with a 15% geared buffer (85% strike) and a digital return of 11.65%. GS Finance also issued another S&P-linked digital deal for $36.22 million. JPMorgan was the distributor for both offerings.

Dual directional notes (or absolute return) have not been as popular as one would expect in this market, sources noted. One possible explanation: they may have been dwarfed by this year’s explosion of digital notes.

“It’s possible that people may prefer the in-the-money digital formula since they get paid a fixed amount even if the underlying is down up to a point. I couldn’t say for sure since we don’t do a lot of dual directionals. We don’t do a lot of digitals either. We prefer income notes where you get paid along the way, “Dueholm said.

Month, year

Issuance by month highlighted four months with sales in excess of $8 billion. In declining order, the best months were September, followed by March, January and February.

For September currently showing close to $9 billion in notional, the market was certainly a driver. The S&P 500 index rallied from Labor Day to the middle of the month, then dropped.

“If early September was the continuation of the summer rally, people may have felt more bullish,” Dueholm said.

“When the market sold off, volatility provided better terms for investors. Banks could also benefit from volatility as they make more money on their hedges.

“When volume picks up, you never know if it’s because it’s more favorable to issuers or if it’s because there is more demand.”

Agents sold $72.7 billion in 16,814 deals this year through the end of October, an 11.8% decline from last year’s $82.44 billion in 24,961 offerings.

The top agent last week was CIBC World Markets Corp. with its $127 million block trade.

It was followed by Goldman Sachs and UBS.

The No. 1 issuer was also CIBC with five deals totaling $158 million.

BofA and Goldman Sachs were respectively the top and second agents last week, according to updated data.

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