Structured notes issuance $385 million for week amid volatile month

By Emma Trincal

New York, Sept. 22 – Structured products agents priced $385 million in 127 deals last week in a choppy stock market rattled by mounting uncertainties, according to preliminary data compiled by Prospect News.

Stocks were down for the second week last week, the S&P 500 index finishing the period 0.6% lower. Markets were volatile ahead of the Federal Reserve’s decision regarding the possibility of a cut in its monthly bond purchases. The September FOMC’s announcement was due on Wednesday.

September surprises

“Last week was not too much of a story. It was much of the same. The market was choppy. Rates stayed low. Funding remained tight,” said Marc Premselaar, senior managing director, capital markets at CAIS.

“But at this junction, the market is going to grapple with even more uncertainty. More risks are looming such as the real estate property crisis in China, inflation, the direction the Fed is going to take today, the debt ceiling issue, the continuing evolution of Covid – that’s a lot. We’ll see how the market will react to the Monday sell-off. It’s a week we need to monitor closely.”

He was referring to a tumultuous trading day on Monday, which saw the Dow Jones industrial average shedding 600 points at the close on fears that Chinese property developer China Evergrande’s potential default may result in global systemic contagion across world markets.

“We’ll see if Monday will be a one-off,” a structurer said.

A rise in volatility would be welcome to improve the pricing of products, sources said.

Stellar year

Sales of structured notes for the year through Sept. 17 continued to soar. Agents during that time have priced $63.35 billion, a 27.3% increase from last year’s $49.77 billion, according to Prospect News data. The year is not over. But it has already generated more than 87% of the entire year 2020, which was the best on record with $72.7 billion.

“This sustained rise in issuance volume is not surprising,” said Premselaar.

“Structured notes continue to find a place in a portfolio as a tool for advisors. They’re not an asset class themselves but rather a solution. They may be used in the alternatives for equities bucket, or for yield enhancement.”

Sources noted that one of the signs of the robust demand is its increase despite the worsening of the terms.

“Banks don’t need the money,” a market participant said.

“The cost of hedging has been going up. Some worst-of notes have gone to four not just three indices.

“Banks have to hedge each index individually and their correlations. It’s expensive to price. Budgets are limited. The terms continue to decline,” he said.

Strong appetite

If banks lack the need for capital and investors the yields they want, why the explosion of issuance volume?

Premselaar offered an answer.

“Funding rates have continued to stay tight, which generally has an adverse effect on a note’s terms,” he said.

“But demand for structured notes remains strong because they solve specific needs in a portfolio.

“If the coupon is off 1% or 2%, advisors may still roll off these deals rather than waiting for higher rates and higher funding spreads. Waiting around has a cost. It’s not always the best strategy. The important thing is to stay in the market and have the investment discipline rather than trying to time the trade.”

The market participant agreed.

“It’s more of a demand thing. More retail investors are starting to discover notes,” the market participant said.

A structurer said that issuance of structured notes had “everything to do” with demand, not with supply.

“Banks don’t issue structured notes to get funding. It’s a misconception,” he said.

“It’s a transaction business. Investors like the payoff offered by the notes. But it’s not as if you could write a contract to retail investors. So how do you deliver that kind of payoff? You issue a note,” he said.

“The agents get their fees, and the desks get paid from trading. This is not about capital raising.

“Volume has exploded because demand is high, not because issuers need the funds.”

Autocalls

Last week continued to see a high share of the volume in autocallables, making for two-thirds of the total amount issued. This proportion is equivalent to the year-to-date average.

Leverage on the other hand represented 15% of the notional last week.

Autocallables benefit from investors’ quest for yield. They may also attract more buyers when volatility spikes as the structure is short volatility.

“We continue to see autocallable income-oriented products dominate given the low interest rate environment and the potential for absolute return with the contingent downside protection they offer,” said Premselaar.

“This week saw the VIX spike, reaching more than 28% on Monday. Last week, the VIX went up too albeit not as much. Nevertheless, the VIX rose above 20 on Friday, which is still off the lows of 16. September is known for its volatility, and we are indeed having more elevated volatility so far.”

One-man show

The number of worst-of notes was down last week with priority given to single underliers whether they be indexes or stocks.

“When volatility rises, investors may be able to reach their yield target with a single index or a single stock versus using the worst-of feature,” said Premselaar.

The majority of stock-linked autocallables were also tied to one name.

Among the most used names were technology stocks such as CrowdStrike Holdings, Inc. DocuSign, Inc. and Snowflake Inc. A name not used in the last six months was Simon Property Group, Inc.

UBS was the top agent for stock deals.

“You would need at least a month of data to see if this single asset trend holds. But if volatility continues to go up, it’s possible that you won’t need to play with correlations to achieve the same yield,” the structurer said.

Top deals

The top deal last week was a simple unleveraged and uncapped participation note.

Morgan Stanley Finance LLC priced $24.92 million of five-year trigger securities on the S&P 500 index giving at maturity the index gain. The downside barrier is 74.5%.

Morgan Stanley & Co. LLC is the agent. UBS Financial Services Inc. is acting as placement agent.

A play between two opposite trends – growth and value – as well as two different market capitalizations allowed BofA Finance LLC to price $24.14 million of three-year trigger autocallable contingent yield notes with a quarterly contingent coupon of 6.47% per annum. The coupon barrier and downside threshold at maturity are both set at 72%.

The return is linked to the worst of the SPDR S&P 500 ETF trust and the iShares Russell 2000 Value ETF.

UBS Financial Services and BofA Securities, Inc. are the agents.

Another structure based on low correlations came from HSBC USA Inc. with $23.89 million of five-year autocallable contingent yield notes linked to the lesser performing of the iShares Russell 2000 ETF and the iShares MSCI Emerging Markets ETF.

The notes will pay a contingent quarterly coupon at an annual rate of 7.4% if each ETF closes at or above its coupon barrier, 70% of its initial level, on the observation date for that period. The notes are autocallables after six months each quarter. The downside threshold at maturity is 70%.

HSBC Securities (USA) Inc. and UBS Financial Services Inc. are the agents.

Morgan Stanley Finance issued a small commodity deal with $3 million of one-year digital notes linked to a WTI crude oil futures contract.

The digital payout is 9.05% payable if the underlier finishes at or above a 70% barrier.

Morgan Stanley & Co. LLC is the agent, with UBS Financial Services Inc. as dealer.

UBS was the leading agent last week with 85 offerings totaling $164 million, or 42.46% of the total. It was followed by Citigroup and Royal Bank of Canada.

The No. 1 issuer was Morgan Stanley Finance with $63 million in 10 deals, a 16.38% share.

For the year to date, Barclays Bank plc continued to be the top issuer with $9.12 billion in 1,568 deals, a 14.4% share.

© 2015 Prospect News.
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