Structured products weekly tally at $153 million in resilient market notching new highs

By Emma Trincal

New York, June 16 – Structured products agents priced $153 million in 131 deals last week in what appeared to be a market defying all logic, according to analysts.

As signs of hot inflation became clear, the stock market hit new record highs while the bond market rallied, pushing yields lower. Separately investors continued to buy structured notes despite lower volatility levels compressing coupon rates.

Sales of structured notes for the year rose 9.4% to $35.17 billion from $32.14 billion through June 11, according to data compiled by Prospect News. A total of 9,773 deals have been priced so far versus 9,721, showing that growth may come from the size rather than the number of deals. However, data is subject to upward revisions both in the deal tally and volume figures.

Inflation? So what

One trend seen last week regarding underlying picks was the rotation back to growth out of cyclicals. This was counterintuitive given that tech stocks suffer the most under inflationary pressures. Pressure could not have been greater than what the Bureau of Labor announced on Thursday: a 5% year-over-year jump in the Consumer Price Index, its biggest 12-month increase since August 2008.

“We have bad inflation. No matter how you measure it, it wasn’t good,” said Steve Sosnick, chief strategist at Interactive Brokers, in a commentary.

“But the stock market seems OK with the CPI numbers.

“Markets are good at rationalizing. Either the markets believe that inflation is only transitory by the Fed definition. Or they think inflation is good for stocks because it provides a hedge against inflation.”

The second hypothesis seemed more of a stretch, he said.

The stock market was more than OK with the CPI figures. After the inflation report release, the S&P 500 index hit a record high followed by a second one on Friday.

Because the market was choppy, the S&P 500 index ended up only 0.4% higher for the week. But the Nasdaq gained 1.8%.

The bond market, which is supposed to be more vigilant about inflation, went on rallying after the report, pushing the 10-year Treasury rate down to 1.43%, a level not seen since early March when inflation headlines were not so prevalent.

The main explanation lies in the message sent by the Federal Reserve calling inflation “transitory.”

Investors may believe the Fed or may have decided “not to fight it,” as the saying goes on Wall Street.

For Sosnick, however, inflation is worrisome.

“It’s getting tougher for the Fed to argue that inflation is transitory,” he said.

Could structured notes issuance be insulated from the market’s price action?

The answer is yes, according to a sellsider, who discarded weekly headlines and macroeconomic events.

“People continue to do the same structures,” he said.

“Most deals have been called away. If a deal on Apple and Amazon gets called, people tend to replace it with the same Apple and Amazon because it’s easier,” he said.

“Macro developments don’t have a distinct impact on how people buy their notes.”

Low vol.

But those developments do impact pricing.

For several weeks, the markets have been tight ranged. Volatility has declined. The VIX index last week was as low as 15, its lowest level since mid-April.

“Coupons have dropped,” the sellsider said.

“When vol. is lower, coupons are lower. It’s just mathematics unfortunately.”

While a two-year worst-of with three indexes and a 60% barrier may have offered yields in a 6% to 7% range only a few months ago, the market is now showing contingent coupons in the 4% to 4.5% range based on the same terms.

But client retention is strong.

While pricing conditions have deteriorated, investors are still buying, the sellsider said.

“The alternatives from equities or the fixed income world are limited. Clients will continue to buy the products even with lower coupons. In some cases, especially with stocks, they’ll add a fourth name instead of three to boost the coupon. But they haven’t shied away from structured notes.”

Call machine

The approaching second-quarter earnings season may be a non-event for the structured products space, he predicted.

“If earnings continue to be strong, we won’t see any bad surprise. The market will continue to stay range bound, which is beneficial for structured notes.”

“Notes will continue to be called away. Market sentiment will continue to be positive. There is money to be invested.”

Part of this sellsider’s upbeat forecast was due to the growing dominance of autocallable notes, which make for two-thirds of total issuance volume this year.

“Those products generate automatic replacement of the money called away.”

This sellsider expects issuance to continue to be strong for the remainder of the year.

“Even if there are fears about inflation, concerns about the next Fed action, structured notes will still be in high demand. They still represent a good risk/reward due to the embedded protection they offer,” he said.

No exit

Sosnick said there are no real reasons yet to exit the stock market. Until there is one.

“Nobody really wants to step away from it too much. The momentum is still there. The trend is still long-term pointing up,” he said.

But there are worrisome signs out there, inflation being one of them, he added.

As long as the market continues to trend sideways, some structures will be more popular than others.

“For range-bound markets, autocalls and digitals are the preferred solution. You have a chance to get a good return even if the market is flat,” a market participant said.

Big rate deal

Just for once, last week’s top deal fell into the interest-rate category. It was an exceptionally large offering, the top rate deal of the year.

Toronto-Dominion Bank priced $50 million of three-year callable capped floating to step-up fixed-rate notes linked to the two-year Constant Maturity Swap rate. The issue was the top rate trade of the year followed by a $25.38 million steepener issued in May by Citigroup Global Markets Holdings Inc.

Interest will accrue at the two-year CMS rate with a floor of 0% and a ceiling of 0.35% for the first year. The rate will be 0.5% in the second year and 0.7% in the third year. Interest is payable quarterly, and the principal is fully protected against market risk.

The notes will be callable quarterly at par after one year.

Another big TD

TD has issued sizable deals of late. One, which priced in the beginning of last month, was an issue of $79.62 million of 15-month leveraged notes linked to the Russell 2000 index. TD Securities (USA) LLC was listed as the agent although the structure (3x leverage up to an 18.54% cap with no downside protection) is the typical “Accelerated Return Note” offered through the BofA Securities franchise.

“Given its size, I would be surprised if this deal was not going to one of the major wirehouses,” the sellsider said.

Two Amazon deals

Playing the regained vigor of growth stocks, Morgan Stanley Finance LLC last week issued $20 million of one-year contingent income autocallables linked to the Invesco QQQ trust, series 1. The protection at maturity was granted via a buffer, not a barrier. The snowball structure allowed for cumulative call premium payments based on a monthly observation. The call threshold of 90% increased the chances of getting the call premium of 9.51% per annum. The placement agent is JPMorgan.

Separately, Citigroup Global Markets Holdings Inc. and Barclays Bank plc each priced a $10 million issue on Amazon.com, Inc.

The 18-month Citigroup notes will pay a monthly contingent coupon of 12% based on an 85% coupon barrier. The structure has a memory feature. The notes are automatically called monthly if the stock closes at or above its initial price. The final barrier level is 85% of initial price.

Also structured as a snowball (memory feature), the Barclays’ notes pay a monthly contingent coupon at an annualized rate of 10.4% based on an 80% coupon barrier. The downside threshold at maturity is set at the same level. The notes are automatically callable on a monthly basis.

JPMorgan is the dealer.

Among the most repeated names seen in tech deals were Advanced Micro Devices, Inc., Micron Technology, Inc., and Nvidia Corp.

Bets on a rebound

The rotation out of cyclical/value stocks into growth is only recent. Before that, investors were betting on a reflated economy via value stocks. They still do.

For a recovery play UBS AG, London Branch priced $12.11 million of two-year autocallable notes linked to an equally weighted basket of four exchange-traded funds – the Financial Select Sector SPDR fund, the Consumer Discretionary Select Sector SPDR fund, the Energy Select Sector SPDR fund and the Industrial Select Sector SPDR fund.

The structure was also a snowball paying an 8% per year call premium with memory, allowing for the payment of past unpaid returns. The notes get called above initial price. The barrier at maturity is 75%.

“I see a lot of deals done on tech but also on the traditional sectors like consumer staples, industrials, which have done pretty well,” the sellsider said.

Underliers for recovery

The most common underliers used for a play on an economic rebound vary across sectors.

General Motors Co., Ford Motor Co., Royal Caribbean Cruises Ltd. and Boeing Co. lead the way in the consumer discretionary sector.

Oil deals use two ETFs – the SPDR S&P Oil & Gas Exploration & Production fund and the Energy Select Sector SPDR fund. But oil stocks abound as well, such as for instance Marathon Oil Corp., Pioneer Natural Resources Co. and Apache Corp.

For last week’s deals on financials, Citigroup Inc. and Morgan Stanley were the most common underlying.

Morgan Stanley is the top agent this year with $8.37 billion in 1,248 deals through June 11, or 23.8% of the total.

It is followed by UBS and BofA Securities.

Barclays Bank is the No. 1 issuer with $5.48 billion in 832 deals, a 15.6% share.

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