Issuers show large deals to wrap up last month, with May tally nearing $6 billion

By Emma Trincal

New York, June 7 – May was not a bad month for structured notes issuance despite competing risk-free fixed-income solutions and a strong AI rally tempting investors to go long the market.

Agents priced $5.83 billion in 1,225 deals in May, according to revised data compiled by Prospect News.

Market up

The Nasdaq and the S&P 500 index were both up 1.8% last week as investors were coming back from a three-day Memorial Day weekend.

The hype around AI has led to record growth from stocks such as Nvidia, whose share price has nearly quadrupled since its low of October.

Are structured notes buyers using the products to take tactical positions on Big Tech? A structurer thought so.

“I think they’re playing the AI rally, of course,” he said.

“They do coupons on Nvidia. They use Nasdaq exposure all the time. Even notes on the S&P are a way to get into this momentum trade since the top components of the index are fueling this rally.”

The largest six holdings of the S&P 500 index, which are mega-cap tech stocks including Apple Inc., Microsoft Corp., Amazon.com Inc. and Nvidia Corp., make for more than a quarter of the benchmark. While lagging the Nasdaq’s performance, the S&P 500 index is up more than 11% for the year.

Year-to-date down

The year-to-date issuance picture is disappointing so far for structured products.

Sales amounted to $34.74 billion in 7,415 deals through June 2 versus $41.33 billion in 12,725 offerings last year, a 16% decline, according to the preliminary data compiled by Prospect News. Those figures are subject to upward revisions in the future.

Mark Dueholm, chief fixed-income trader at Landolt Securities, was not surprised.

“Our own volume is down a lot. The reason is very simple: regular interest rates, especially short-term rates, are quite high. The alternatives to structured notes are very attractive,” he said.

A three-month T bill is yielding 5.32% and a six-month, 5.44%, he noted.

“It’s tough to pitch structured notes when clients can get 5.5% in six months risk-free.

“When talking to a client you could say: what if rates drop? How will you reinvest in six months? The counter-argument is: ‘if I can get 5% on a six-month tenor without risk, I’ll take it.’

“A lot of people think that way. Treasuries have no risk. It’s hard to argue with that. In fact, I can understand that.”

Pricing conditions

Dueholm pointed to another factor impeding sales of structured products.

“Two things matter when you price structured notes. Interest rates and volatility. Ideally you want both to be high,” he said.

“We do have higher rates, but it’s mostly on the short end where the Fed is tightening. On the long end, rates are lower because people expect a recession. They expect rates to drop so they buy longer-dated Treasuries to lock in current levels.”

But the real impediment is volatility, he noted.

“Volatility is very, very low, so coupons are not good compared to what they used to be.

“And uncertainty is very high. Plus, the market is kind of high. You’re not getting a good entry point, which limits the amount of protection you can get.

“As a result of all of this, people are not really excited.”

Given the current recovery rally, one would expect a greater bid on leveraged notes. But issuance volume for these products has also declined this year although the market share of unprotected leverage has remained constant year over year at 7% of total sales.

“People who are really bullish go long equities. Overall, for a lot of people, the value of structured notes is to get income, not necessarily growth,” he said.

May deals

Last month saw a fair number of larger offerings. Agents priced $1.2 billion in deals over $30 million, which represented 21% of the total notional for that month. In comparison, January saw only $919 million of such deals, a 13% share.

The top deal last month was HSBC USA Inc.’s $92.53 million of 14-month Accelerated Return Notes linked to the S&P 500 index distributed by BofA Securities, Inc. The payout is triple any index gain, up to a 15.57% cap with no downside protection.

Those capped leveraged notes coming from the BofA franchise tend to be sizable trades.

In-the-money digitals

More surprising was the size of digital notes linked to the S&P 500 index brought to market by JPMorgan Chase Financial Co. LLC for $92.24 million. The digital option was “in-the-money” meaning that the initial price was above the digital strike of 85%. The payout is 11.2% if the index finishes at or above the strike. The protection consists of a 15% geared buffer.

Morgan Stanley Finance LLC followed suit with $89.81 million of 18-month in-the-money digital notes on the S&P 500 index providing an identical payout structure: a digital payment of 13% if the index finishes at or above 85% of the initial level and a 15% geared buffer for protection purposes.

Morgan Stanley & Co. LLC is the agent.

Cookie-cutter sales

Those short-term, in-the-money digital notes with geared buffered protection have become a template in the market, which may explain the size of those deals, the structurer said.

For instance, the majority of those in-the-money structures feature the same 85% strike level with the corresponding 15% geared buffer.

“That’s the structured products model. Brokers and advisers want cookie cutter deals. They hate having to explain new things. A long time ago, the big joke used to be: what do people want after the reverse convertibles? More reverse convertibles,” he said.

Common wishes

Eventually new types of structures will emerge. If successful, firms will price copycat deals making the new structure mainstream, he said.

“Then you’ll see the same type of deal shown over and over by different banks. In some cases, the same terms may be used again and again as long as they satisfy what people want,” he said.

Investors ultimately want the same things, he noted, citing a double-digit coupon, short tenor and a 65% barrier.

“If the issuer can’t offer those terms, something has to give. If the market goes in a certain way, the terms have to be adjusted. That’s when people have to decide if they want to take more risk to reach their objectives,” he said.

Another factor limiting innovation came into play.

“When you sell structured products, you don’t strive to give investors a 20% coupon because you would spoil them. The next time you show them something, they may raise objections. This is why a certain level of standardization is required,” he said.

Earlier last month GS Finance Corp. priced $57.19 million of two-year digitals on the S&P with slightly different terms. The digital strike was at 90% of the initial level, the payment, 20.57% and the buffer 10%.

Goldman Sachs & Co. LLC is the agent.

Big dual directional

Absolute return notes did not use to be big trades. But Bank of Nova Scotia two weeks ago priced $84.92 million of such a deal.

Linked to the S&P 500 index, the notes offered at maturity par plus any index gain, capped at par plus 10%. A 14% buffer provided protection and absolute return above the 86% threshold.

BofA Securities, Inc. was the agent.

The use of buffers on those dual directional deals explains the bigger sizes, said the structurer.

“You couldn’t price buffers a year or so ago. Now you can, mainly because of higher interest rates more so than volatility, which remains low,” he said.

Other asset classes

ETFs have seen their volume increase by 25.7% this year. The use of ETFs replicating the broad indexes is a big factor behind this trend. But investors lately have resumed sector plays. A notable example was Scotia’s $48.24 million of 14-month leveraged notes linked to the Energy Select Sector SPDR Fund, which pays triple any ETF gain up to a 34.66% cap. BofA Securities, Inc. distributed the offering.

In other asset classes, JPMorgan Chase Financial two weeks ago priced $38.84 million in enhanced trigger jump securities on the WTI crude oil futures contracts.

On the single stock side, Royal Bank of Canada issued $34.1 million of autocallable notes tied to Microsoft Corp.

The top agent in May was JPMorgan with $1.12 billion in 236 deals, or 19% of the total.

It was followed by Morgan Stanley and UBS.

The No. 1 issuer was JPMorgan Chase Financial, which brought to market $1 billion in 218 deals, a 17.2% share.

© 2015 Prospect News.
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