Structured notes sales hit $271 million for week; volatility expected to help pricing

By Emma Trincal

New York, Oct. 28 – Structured notes issuance amounted to $271 million in 79 deals during the week ended Oct. 23, according to preliminary data compiled by Prospect News, amid choppy equity markets in the run-up to the U.S. Presidential Elections

Figures will be revised upward after more deals get filed with the Securities and Exchange Commission.

The updated tally for the previous week ended Oct. 16 was $773 million in 210 deals.

Choppy market

The market was volatile last week given an extraordinary uncertain political and social environment.

With only a few more days to go before the Elections and the market fixated on the hope to see a deal between U.S. Treasury secretary Steven Mnuchin vanishing, along with rising cases of Covid-19 spurring fears of new lockdowns, especially in Europe where partial shutdowns have already been implemented, the S&P 500 index fell by 0.53, a small drop but the first since September.

The Dow Jones industrial average dropped 0.95% and the Nasdaq Composite lost 1%, also losing ground after a four-week rally.

Two thirds in autocalls

The usual underlying and structure trends remained the same last week but took an extreme turn.

Autocallable contingent coupon notes for instance amounted to three-quarters of the weekly issuance volume, a share that is well above the year-to-date average of 50%.

This trend was already visible for the month with 65% and 12% shares for autocallables and leverage, respectively. The data is far from complete both looking backward with expected updates and forward with this week seeing the pricing of big leveraged notes to close the month. However, there is no doubt that autocallables are the structure of choice for advisers and has been for the entire year.

Phoenix money

Ed Condon, portfolio manager at Bluestone Capital Management, said he was not surprised by the abundance of autocalls in the market as a percentage of the total notional.

“In the first quarter, when volatility spiked and coupons were very high, there was a big rush to buy these autocalls,” he said.

“Then came the recovery rally. Market levels were higher. Since those notes were autocallables, after three or six months they did get called and all that money rolled over. That’s why you see such a high proportion of autocalls.

Conversely leveraged notes, which are structured as bullet notes, do not offer reinvestment opportunities.

Leverage

“It’s my understanding that earlier in the year, the terms on these levered notes were exceptionally good,” Condon said.

“The payouts and protection generated at the time attracted a lot of money, and since those deals don’t get called, once the money goes in, it doesn’t get out so easily,” he said.

Correlation and pullbacks

The importance of worst-of notes issuance may slightly diminish if the market turns negative.

“We’re just ahead of the Elections and several countries in Europe are reinstituting lockdowns or partial lockdowns,” said the sellsider.

“Volatility is rising as a result and the chances of a sell-off are increasing. When volatility rises, you don’t need to take on the worst-of risk as much.”

Moreover, if the stock market pulls back significantly, correlations tend to be higher, which also reduces the benefit of worst-of payouts, he added.

“You don’t want high correlations when you price a worst-of. The lower the correlation, the higher the coupon.

“When volatility spikes, you get strong correlations between indices. Everybody sells everything. It doesn’t matter anymore. During a market crash, indices move in the same direction. They all go down. There’s no good reason to use a worst-of anymore,” he said.

Health crisis

This sellsider said he had no doubt that volatility is going to soar. He expects a short-term pullback in the market.

“We have no visibility over the short-term. The market is going to be very volatile over the next few months. It’s not just the Elections in the U.S. Look at Europe.

“The rise in coronavirus cases is increasing in the U.S. but especially in Europe, and lockdowns are coming back. They are necessary but they will put more people out of work – restaurants, hotels, the entertainment industry, the travel industry... basically anyone who can’t afford to work from home. That’s a lot, and it’s going to increase inequalities. You’re going to see a huge wave of bankruptcies because all of those small businesses locked down in the spring have not recovered at all and now, they’ll just go under.

“So, there is a reason to be concerned about the coronavirus. That’s why the market has been selling off recently. Those shutdowns could really precipitate a recession,” he said.

Last week saw a surge in single-stock-linked notes issuance, which represented a third of the total. Equity indexes on the other hand made for a little bit more than half of total sales.

Single-stock deals tend to be appealing when volatility is up. Earnings season was a factor, especially for tech stocks, the darling of the underlying universe.

Awaiting big Thursday

The so-called FAANG stocks (Facebook, Apple, Amazon, Netflix and Google’s parent company, Alphabet) as well as Microsoft were among the most popular underlying last week.

Earnings played a major role.

This Thursday, five of the largest mega-tech companies – Apple, Amazon, Microsoft, Facebook and Alphabet are expected to report their earnings.

As Steve Sosnick, chief strategist at Interactive Brokers, recently said in a research note, “Oct. 29 afternoon will be the mother of all earnings releases. Those are the top five companies in the Nasdaq-100 index representing nearly 45% of the index’ market capitalization! For perspective, those stocks represent about 22% of the S&P 500 index market cap as well. It is crucial to see what the options market expects for those names.”

Structurers who price deals based on the volatility of the embedded options were therefore particularly busy pricing autocallable notes with the best possible terms on those high-flying names.

Tech deals

Royal Bank of Canada priced $13.2 million of three-year autocallable contingent coupon barrier notes linked to Amazon.com, Inc. This deal will pay a modest 6% contingent coupon but protects investors deeply, up to the first 50% in decline.

Morgan Stanley Finance LLC priced another three-year autocallable deal for $11.43 million linked to Netflix, Inc.

The 12.45% contingent coupon is observed quarterly based on a 65% coupon barrier, which is at the same level as the final downside threshold. The notes are autocallable quarterly.

Morgan Stanley Finance priced two other three-year autocallable contingent coupon notes offerings, each showing 65% barrier both for the coupon and for the principal repayment. One, which priced for $9.33 million, was tied to Microsoft Corp. paying 8% in annualized contingent coupon; the other, for $9 million, is tied to Apple Inc. and offers a 9.9% coupon per year. GS Finance Corp. priced another autocallable deal on Apple for about $8 million.

These were among the largest “stock” deals, an asset class that tends to show smaller sized deals than index-linked notes. But most stock-linked notes were built on tech names – 90% of their volume and 60% of the deal count for this asset class.

Baskets, sectors

The asset class picture was slightly different for baskets of stocks and exchange-traded notes. There, especially with ETFs, precious metals shined. The VanEck Vectors Gold Miners ETF and the iShares Silver trust have become increasingly popular due to their potential to hedge a market downturn and high volatility replacing the common use of energy stocks a couple months ago.

Top two

The top two deals last week remained based on diversified assets, either indexes or their ETF equivalent, excluding the riskier sector ETFs.

Citigroup Global Markets Holdings Inc. priced the top one for $36.94 million. The 10-year maturity was noticeably long for a worst of the iShares MSCI Emerging Markets ETF and the SPDR S&P 500 ETF Trust.

The notes pay a 6.31% coupon paid on a contingency basis. The payment is based on a 70% coupon barrier observed quarterly with a quarterly autocall feature kicking off after a year. The principal repayment barrier at maturity is 60%. UBS is the agent.

Morgan Stanley Finance’s $32.21 million of two-year “snowball” autocallables was the second top offering. Some of the advantages include a short tenor, a single asset exposure and a downside buffer. The 8.9% call premium paid annually if the index is above its initial level cumulates into 17.8% in year two due to a memory feature. A 10% geared buffer with a 1.11 leverage factor provides a hard protection.

American barriers

A trend spotted last week in a number of deals was the use of “American” coupon barriers. The term “American” designs a daily observation of the underlying price in relation to the coupon barrier level during the quarter rather than once on the quarterly observation date as it is generally the case.

An example is Barclays Bank plc’s $15.55 million of two-year trigger callable contingent yield notes with daily coupon observation linked to the worst performing of the MSCI EAFE index, the Russell 2000 index and the S&P 500 index.

Each quarter, the notes will pay a contingent coupon at an annual rate of 9.45% if each index closes at or above its coupon barrier level, 70% of its initial level, on each day during the relevant quarterly observation period.

UBS is the agent.

In the same way, Morgan Stanley Finance priced $10.67 million of three-year trigger callable contingent yield notes with daily coupon observation linked to the least performing of the S&P 500 index, the Russell 2000 index and the Euro Stoxx 50 index with a 10% contingent coupon annual rate and a 65% American coupon barrier.

The same issuer brought to market a similarly structured note due Jan. 25, 2024 on the least performing of the S&P 500 index, the Russell 2000 index and the Nasdaq-100 index.

Year to date

Volume for the year through Oct. 23 is up 39.2% to $54.7 billion from $39.28 billion. The deal count is up by a third to 17,042 from 12,782.

While the advance recorded earlier this year has decreased, the final weeks remaining before the end of the year appear promising despite or perhaps because of the expected short-term volatility.

“I’m optimistic about issuance levels going into the end of the year,” said Condon.

“Advisers will see the remainder of the year as an opportunity to lock profits in. There may be some advisers that will expect a sell-off and will sit on the sidelines. But that has not materialized yet.”

To the extent that some money is on the sidelines, advisers will put that to work, he predicted.

“The risk has been on the upside this year. Trailing the market has been worse for advisers.

“If you didn’t invest money for investors this year, you fell way behind.

“I’m optimistic about the country recovering. I see issuance levels continuing to grow.”

The top agent last week was UBS with $139 million in 55 deals, or 51.1% of the total.

It was followed by Morgan Stanley and Goldman Sachs.

The No. 1 issuer was Morgan Stanley Finance, which brought to market $87 million in nine deals, a 32.2% share.

For the year, Barclays Bank is the top issuer with $7.91 billion in 1,634 deals, or 14.46% of the total issued.

© 2015 Prospect News.
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