August’s structured product sales near $3.1 billion despite Fed, Delta, China crackdown concerns

By Emma Trincal

New York, Aug. 25 – The summer is not slowing down for structured notes sales so far even if last week’s equity market finished slightly lower as uncertainty mounted around an array of issues, from geopolitical tensions to possible changes in monetary policy.

Agents sold $3.09 billion this month through Aug. 20, a 35.4% increase from the same period a year ago, according to data compiled by Prospect News.

Last week’s data showed $405 million in 178 deals.

These figures are preliminary and will be revised upward. Just for the prior week ended Friday Aug. 13, revised figures revealed a $1.165 billion tally, a high number for this early part of the month.

Fed repercussions

The stock market slightly dropped last week after a two-week winning streak. The S&P 500 index was down 0.6%.

The release of the Federal Reserve minutes from its July meeting triggered a sell-off on Wednesday, as it revealed that more Fed members were inclined to cut their monthly bond purchases later this year. Market participants expect to know more this week during the Fed’s policy symposium in Jackson Hole coming up Friday.

“All eyes are on Jackson Hole. I hope we’ll get some volatility but I’m not even sure because it may have already been priced in,” a sellsider said.

“People expect yields to rise if the Fed tapers, which would also be good for pricing of structured notes. But I think it will be muted.”

A not-so-high increase in bond yields would in turn be good news for the marketing of structured notes as their popularity relies on providing above average income, he added.

“Even if the Fed pushes yields higher by cutting its bond purchases, we’ll still continue to see international buyers piling into U.S. Treasuries because yields are so much lower in Europe and just about anywhere,” he said.

“It’s almost a vicious cycle. The Fed is trying to mitigate inflation. If they taper and manage to push yields higher, international investors will continue to buy Treasuries offsetting the Fed move in pushing the yields lower.”

Strong year

Issuance volume this year is already up 22.5% to $54.47 billion through Aug. 20 from $44.49 billion last year.

The deal count for this year is 14,889 versus 13,532 for last year, a 10% increase.

“We’re turning more mainstream,” the sellsider said.

Volatility has been contained most of the year except for short-lived spikes as the bull market pushed stocks higher with the averages breaking new record highs sometimes on a weekly basis. For the year, the S&P 500 index has gained nearly 20%. While many investors have been seeking higher returns directly from the stock market, many others have turned to structured notes for downside protection fearing a pullback in a toppish market, the sellsider said.

The combined search for yield and protection has contributed to a very strong year so far, he said.

Bulls in control

As more investors worry about a pullback, a change in the super easing monetary policy is on everybody’s radar screen. But the sellsider downplayed the risk of a shock.

“I don’t even know if volatility will go up as we recently passed the new spending bill.

“Yes, there are concerns with the Fed and the Delta variant. Afghanistan is sad but I’m not sure it has a meaningful impact on the market. China’s crackdown on big tech is a concern but it should work itself out. Overall, as we’re going through the dog days of summer, structured notes continue to be in high demand. We are very busy especially with income deals, which is where most of the demand is.”

For this sellsider, investors have good reasons to remain bullish.

“The market continues to run because there are still reasons for stocks to go up. The earnings are showing that companies are doing well. People say the market is overvalued. I’m not going to disagree. But it’s backed by earnings,” he said.

He does not project any big market move as long as investors are still on vacation.

“The longer this bull run goes, the greater the risk of a shock. Do I think it’s coming? I don’t anticipate this during the rest of the summer. Let’s wait until Labor Day,” he said.

Rather than the Fed, a possible “shock” to the market could arise from schools.

“School closures would weigh on the market by raising new concerns about the Delta variant, vaccines, economic growth, and supply chain disruptions,” he said.

“I think it would have a significant impact.”

Index worst-of autocalls

Last week’s dominant product was again the autocall, making for 75% of total sales. Leverage represented 20% of the notional, and digital notes, about 5% of the total.

On the asset class side, equity indexes dominated, making for two-thirds of the volume in $267 million and 29 offerings.

ETF-linked notes were absent. Stocks showed a 30% share.

A market participant explained why indexes remain so popular.

“Indices remain the top asset because many prefer making bets on broad-based, predictable benchmarks,” he said.

“Sector ETFs have been popular. But they’re still a riskier bet than indices. And you have to have enough option liquidity to put together a note, so issuers often end up doing broad indices ETFs like QQQ, SPY or IWM.”

The tickers QQQ, SPY or IWM refer to the funds tracking the Nasdaq-100 index, the S&P 500 index and the Russell 2000 index, respectively.

“Of course, you can get pretty good terms with individual stocks, but not everyone wants the company risk,” he said.

Less heated Europe

European benchmarks made a comeback last week. They represented 22% of total sales in six offerings totaling $88 million, which include worst-of.

For the most part, European exposure was achieved through the Euro Stoxx 50 index within a worst-of basket including two U.S. equity indexes. Smaller deals came out with only one index, essentially the MSCI EAFE, which is viewed as a proxy for European stocks as 60% of its constituents are European-based companies.

“People feel that European underlying are stable because of the very accommodative policy in Europe,” the sellsider said.

“The view is we’re not likely to see a pullback in Europe because Europe is turning Japanese. It’s a market that could go down but not down 40%.”

Yet the lower correlation between the Euro Stoxx and U.S. benchmarks helps the pricing, he noted.

“As people get more and more comfortable with worst-of, they’re more open to the idea of mixing U.S. with European equity and why not if you can get a yield pickup,” he said.

However worst-of notes tied to a mix of U.S. and non-U.S. assets may pose problems for asset allocators.

“It’s not for everyone, though, because it’s harder to put in a portfolio. When you use the S&P and the Russell, there may be nuances. But both are still U.S. equity, so it’s easier from an asset allocation standpoint,” he said.

Issuer calls

Last week saw the pricing of two large income-oriented notes through the UBS platform.

In the first group an example is Barclays Bank plc’s $33.97 million of three-year callable contingent yield notes with daily coupon observation linked to the worst performing of the Euro Stoxx 50 index, the Russell 2000 index and the S&P 500 index.

Each quarter, the notes pay a contingent coupon at a rate of 8.7% per year if each index closes at or above its coupon barrier level, 70% of its initial level, on each scheduled trading day during that quarter.

The notes are callable on any quarterly observation date.

The downside threshold at maturity is 65%.

Separately another large deal displayed similar characteristics except for its exposure, which was entirely domestic.

Citigroup Global Markets Holdings Inc. priced $41 million of three-year callable contingent yield notes with daily coupon observation linked to the worst performing of the S&P 500 index, the Russell 2000 index and the Nasdaq-100 index. The American coupon barrier was set at the same level of 70% as well as the 65% barrier at maturity. The coupon rate was 8.5%.

MSCI plays

Single asset deals with European exposure included JPMorgan Chase Financial Co. LLC’s $25 million of 13-month return enhanced notes linked to the MSCI EAFE index.

The leverage is three times and the cap 12.5%. Investors are fully exposed to any index decline.

Another MSCI leveraged deal was Morgan Stanley Finance LLC’s $9.16 million of 16-month leveraged buffered notes paying 1.1 times the index gain, up to a 14.674% cap. The downside included a 10% geared buffer.

Airlines, fixed rate

On the single stock side, a noteworthy deal, also distributed by UBS, was HSBC USA Inc.’s $15 million of 7.7% airbag autocallable yield notes due Aug. 23, 2022 linked to Southwest Airlines Co. with a conversion price of 85%.

UBS was the top agent last week with $213 million in 144 offerings, or 52.65% of the total. It was followed by Morgan Stanley and Citigroup.

UBS AG, London Branch was the No. 1 issuer last week with $89 million in 135 offerings, or 21.9% of the total.

For the year, the top issuer is Barclays Bank with 1,375 deals totaling $8.08 billion, a 14.8% share.

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