September outlook for structured notes looks bright, structurer says; $215 million priced for week

By Emma Trincal

New York, Sept. 16 – While data for September remains muted, it is preliminary, and sources are optimistic about the outlook for the month.

Agents priced $215 million in 88 deals in the shortened holiday week following the Labor Day holiday, according to initial data compiled by Prospect News.

Figures will be updated upwards when more deals get filed with the Securities and Exchange Commission.

Revised data for the previous week showed $939 million in 437 deals, a healthy tally for the beginning of a month.

Part of it coincided with a correction in the technology market, which started on Sept. 2.

The market continued to be volatile last week. The S&P 500 index tumbled 2.5% and the Nasdaq Composite index dropped than 4%, falling into correction territory on Tuesday.

Big cap tech

The tech sector has been the main driver behind the recovery trade which led the markets to new all-time highs this month after a stock market crash between Feb. 19 and March 23. Now a nascent trend points to renewed volatility in the sector adversely impacting the rest of the market as well.

“This recent tech sell-off is actually a good thing for issuance, especially for income notes,” said a structurer.

“These stocks have been popular for years and when they dropped in March, there was a great opportunity to produce some pretty attractive yields. But they came right back in just a few months, hitting new highs, which didn’t make them quite as attractive as they were back in March.

“The rocky market in the past couple of weeks is giving people a new window of opportunity.”

Non-tech names have not received the same attention. Yet, they can also offer some appeal.

“Now you have opportunities in other sectors. It’s the bigger tech stocks that have been pulling the market up. Most other names have not been rallying that much. So, you can get good terms as well,” he said.

Stimulus and Fed

Investors are unsure whether the current pullback will get worst. Some predict that the market will stay in a trading range.

The recent volatility could be an incentive for buyers of structured notes to enter trades at a better price or to play range bound through income-generating autocallables.

Part of the recovery was due to the Federal Reserve maintaining low rates and recently reiterating this objective by stating that it will tolerate some level of inflation to support employment, sources said.

In addition, the coronavirus stimulus package has kept the economy afloat even if Congress remains at a standstill about the next plan.

Tom Balcom, founder of 1650 Wealth Management, has been warning his clients prior to the sell-off “not to become too complacent” when it comes to the recovery in the stock market since its March lows.

“Those who become overly aggressive when the market has reached or is reaching its all-time highs are often disappointed during pullbacks,” he said.

Not the end of the tunnel

Some firms have been cautious about current market conditions.

“The tech industry is a bit too volatile to be used as income-producing investment for a client,” said Andrew Valentine Pool, main trader at Regatta Research & Money Management.

“Values are only down a small percentage compared to the increase seen in the past year, or year-and-a-half. It doesn’t convince us that it’s such a great time to get into a trade.”

Pool said he is concerned about a deeper market pullback.

“To us the recovery has been a false run because the Federal government is funding a lot of the support,” he said.

Pool said he is concerned about what might happen when that government support starts to go away.

It is too soon to evaluate the strength of issuance volume for the month as not all deals have been included in the database yet. But sources are optimistic.

Year, month

Volume for the year is up 43.1% to $47.71 billion from $33.34 billion, according to the data.

The number of deals surged by 36.2% to 14,794 from 10,861.

“We got a strong start this month partly due to that tech correction. Larger deals came though at that time,” the structurer said.

“It remains to be seen whether it continues to be the case ahead from where we are.

“But it’s pretty clear that the correction helped drive some of the volume. We could potentially have a bigger month than August.”

The nature of the deals being printed is also an engine of growth. Autocallables dominate the market, and when the deals get called, investors tend to reinvest based on the positive experience of collecting a coupon or premium with full principal.

Last week for instance was exceptionally strong in autocallable issuance: 85% of total sales fell into this category. It is possible that bigger leveraged notes filed later on the SEC website would modify this proportion. But already for the year, autocallables account for 51% of the total.

Positive signs

Getting better yields and barriers is not the only reason to buy autocallables during a pullback.

In general advisers are increasingly forced to look for yield regardless of market conditions.

“Currently we’re looking at the income arena more than the growth-types of notes,” said Pool.

“There is a real income problem. The Fed has kept interest rates so low, and it looks like it’s going to continue for some time.”

The thirst for yields and the autocalls getting called are promising signs for increased sales looking into the fourth quarter.

“It’s encouraging that September falls into the second quarterly date for all the autocalls that struck in March, and there were quite a lot,” said the structurer.

“They’re going to be called in September. And it will be across the board, because even if not every stock has recovered to the same degree as tech, they’re still higher than the March lows.”

One index for once

As volatility measured by the CBOE VIX index surged last week, reaching 35, its highest level since June when it was near 45, issuers had enough ammunition to price autocallable deals on a single, broad-based index, something they cannot do when the market rallies.

The top deal was from UBS AG, London Branch, with $29.99 million of three-year autocallable contingent yield notes linked to the S&P 500 index.

The annual contingent coupon is 8.25% payable quarterly based on a 70% coupon barrier.

The notes will be called quarterly above the initial price. The barrier at maturity is 70%.

“For a broad-based index, not a worst-of, that coupon is pretty attractive. It must have struck on one of those recent lows,” the structurer said.

The notes priced on Sept. 8, the second lowest point last week after Friday.

“The drop in big tech prices has been a catalyst. A sudden spike in volatility will help a lot,” he said.

Long maturities

Another top deal structured on a single index was Citigroup Global Markets Holdings Inc.’s $20 million of 10-year autocallable securities also on the S&P 500 index.

The notes will be called at par plus a call premium of 9.85% per year if the index closes at or above its initial level on any annual call date.

The notes offer a 98.5% upside participation at maturity and full downside exposure.

“We don’t see extended maturities. Issuers are not willing to take longer term risk at this point. The further they’re willing to go is five years. Most issuers go even less than that,” said the structurer.

“It has become much trickier to price these long-term deals. They’re backing away from doing that.”

Bank of Nova Scotia priced another long-term S&P deal for $17.42 million in the form of a six-year autocallable market-linked step-up with a 15% buffer. The notes pay an annual call premium of 6.67% above intimal price. At maturity, investors get the greater of 35% or the uncapped index gain.

BofA Securities, Inc. is the underwriter.

Themes

Another trend seen last week was the use of stocks or ETFs to play a tactical theme.

Volatility allowed for the payment of fixed rates on some of those deals.

Barclays Bank plc priced $10 million of one-year 17.85% fixed-coupon autocallable securities linked to Delta Air Lines Inc. with monthly interest payments and a 60% barrier.

Morgan Stanley is the dealer.

“This is a play on a continued recovery. The idea is that after Covid, the economy will return to normal,” said the structurer.

Teleconferencing stock Zoom was another play on the pandemic theme.

UBS AG, London Branch priced $10 million of one-year 16.25% income autocallables securities linked to Zoom Video Communications, Inc. This deal was also distributed by Morgan Stanley. Calls and coupon payments are monthly. The final barrier is at 50%.

“The stock has been up a lot as a stay-at-home kind of story. Now it could also be a play on the post-Covid economy. The idea is that even past the pandemic, some of the ways of doing business will be here to stay, like teleconferencing. So, it has more room to grow,” the structurer said.

Crazy high-flyers

The tech pullback last week was a good opportunity to enter some deals on the most favored – and most overpriced – sector of the market.

Several deals priced on the top five tech names, the so-called FAANG stocks.

Tesla’s meteoric valuation – the stock is still up 435% for the year – did not seem to scare some investors making short-term bets on the electric carmaker.

Morgan Stanley priced $10 million on the behalf of Barclays Bank plc tied to Tesla with a fixed 16.85% annual coupon on a one-year term. The payout was identical to the Zoom deal: monthly autocalls and a 50% barrier at maturity.

HSBC USA Inc. issued and sold its own Tesla deal for $5.26 million with similar terms and a 28.5% fixed coupon.

The top agent last week was UBS with 67 deals totaling $89 million, or 41.3% of the total for the week.

It was followed by Morgan Stanley and Citigroup.

The top issuer was UBS AG, London Branch with $65 million in 64 offerings.

For the year, the No. 1 issuer is Barclays Bank plc with $7.27 billion in 1,485 offerings, a 15.2% share.

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