Structured notes issuance $214 million for week; yearly gains slowing despite rally, reopening

By Emma Trincal

New York, June 10 – A total of $214 million in 81 structured notes priced last week, according to data compiled by Prospect News, in the midst of a stock market rally prompted by unexpectedly strong jobs data.

The S&P 500 index surged 4.9% for the week after the labor Department reported 2.5 million more jobs last month.

Issuance figures for the last week of May were revised upward, pushing up the tally for last month to $4.48 billion in 1,563 deals. This notional amount is still 5% lower than April’s $4.72 billion. It’s also less than a year ago by nearly 10%. May’s totals last year amounted to $4.965 billion.

Year to date

This year’s volume was exceptionally strong mainly during the first quarter, which recorded $21.5 billion in sales. That was twice as much as last year’s first quarter, which saw the pricing of $10.8 billion.

This momentum gave the year to date a solid advance up to a point. Recently, with the past two months much weaker, sales through June 5 have increased by 51.75% from $20.32 billion to $30.84 billion through June 5. It’s still a strong growth but one that’s a far cry from the 100% jump seen earlier this year prior to the coronavirus pandemic and the lockdowns.

Pricing on stocks

“It’s hard to say why we had a slow volume in May. There can be a seasonality element to it. But I think it’s primarily the uncertainty,” a sellsider said.

Volatility is high, which has shifted demand toward products that benefit from wider price moves, notably autocallables, he explained. When investors demand coupons on indexes, there is often no other choice than using worst-of structures. With single stocks, however, investors may get attractive yields and barriers depending on the volatility of the underlying.

“When you link notes to single stocks, you can find deals that price really well,” he said.

Harder to find

The same can’t be said about leveraged products.

“For participation notes, pricing has tightened dramatically. Principal-protection notes are hard to create as well,” he said.

“Rates are so low the zero-coupon component doesn’t leave much room to build upside participation.”

One aspect of a possible slowdown in demand could be that advisers are not able to find deals, which were available only a few months ago.

“Clients can’t get the 10%, 20% hard buffers they used to have,” he said.

“Leverage up to a cap gives you much lower caps than before.

“When terms are tightening on those popular types of notes, it may have an impact on volume.

“For those advisers who systematically purchase leveraged notes every month, not finding the terms that they want could certainly lead them to sit on the sidelines.”

Autocalls

Last week’s distribution between growth and income (autocallable) products was more even than usual, split as a share of total volume as 35% and 39%, respectively.

It was very different from the average for the year, which is now showing 50% in income notes versus 28% for leverage.

Last year, the distribution was even: each product type represented approximately 36% of the total.

Going back to Jan. 1, 2004 through the end of 2019, leveraged prevailed at 35% of total issuance volume against 20% for autocallables.

The sellsider said that the growth in autocall sales is a recent and robust trend.

“Autocalls are a much bigger market in Asia, Europe and Latin America. The U.S. has been lagging and is starting to catch up with what’s been popular for years in these other parts of the world,” he said.

No discretion

The overwhelming majority of callable structured notes are based on automatic rather than discretionary calls as it is the case in other segments of the debt market. This sellsider explained why.

“People prefer automatic calls versus issuer calls because there is more certainty,” he said.

“It’s rules-based. There’s less ambiguity regarding what’s going to trigger the early redemption.”

He advanced another reason.

“We’ve heard from advisers that autocalls respond much better than issuer calls to an upward market on secondary pricing,” he said.

“With an issuer call, the market could be up, but the valuation of the notes is going to lag. The clients look at their statements and they don’t understand why the market is up and their investment, down.

“If it’s an autocall, the valuation of a secondary bid is going to be responsive to an upward market.

“That’s a very big advantage.”

Big rates deal

Last week’s relatively solid volume for the first week of a month may partly be attributed to three larger trades.

Intriguingly, the top one was a rates-linked note offering.

Bank of Montreal priced $51.7 million of three-year floating-rate notes linked to the two-year Constant Maturity Swap rate. The interest rate is equal to the two-year CMS rate, subject to a floor of 1.1%. Interest is payable quarterly.

“It’s very attractive. What surprises me is that the 1.1% floor is four times as high as current two-year CMS. To be able to get 1.1% on a three year in this environment is quite good,” the sellsider said.

Two leveraged plays

Next, Morgan Stanley Finance LLC priced $42.31 million of three-year leveraged buffered notes on the S&P 500 index.

If the index return is positive, the payout at maturity will be par plus 150% of the index gain, capped at par plus 23.5%. Investors will receive par if the index finishes flat or declines by 25% or less and will lose 1% for every 1% that it declines beyond 25%.

“That’s a big buffer to get on the S&P on just three years,” the sellsider said.

“The 23.5% is about 7.8% a year, which is around the average return of the S&P on a normal year.

“You’re trading some upside participation for the protection, and given how much of a buffer you get, this is not too bad.”

Separately, Citigroup Global Markets Holdings Inc. priced the third-largest deal with $32.03 million of 18-month leveraged notes also tied to the S&P 500 index.

This time the structure offered no downside protection. The payout at maturity will be 3 times any index gain, up to a 19.8% cap.

Aggressive buying

Some market participants argued that it’s time for investors to hedge their positions. For some advisers, the traditional leveraged buffered note would be more appropriate in this overheated market than short-volatility securities like barrier autocalls.

“We’re doing fewer deals each month because we’re buying structured notes for growth or to hedge the portfolio. We don’t see that much of this anymore,” a buysider said.

Since its bottom in March 23, the S&P 500 index has shot up 48%. The market rallied for the third week in a row last week. Technology stocks continue to lead the bull market as evidenced by the Nasdaq-100 recording 27 new highs this year, according to Barchart.

Fears about the coronavirus spread seem to have receded at least for now. But some suggest that the market is mispricing an economic recovery with too many hopes and little analysis.

Correction looming

“Lastly, the market has rallied over the past week on ‘better than expected’ economic data, which supports hope of a ‘V-shaped’ economic recovery,” said Lance Roberts, chief portfolio strategist/economist for RIA Advisors, in his recent “Technically Speaking” note.

“Investors may be getting too far ahead of themselves in the short-term.

“Given the market is now pushing a 3-standard deviation move to the upside, with indicators very overbought, a short-term corrective action is likely.”

Some worrisome indicators signaling overbought conditions and a likely correction, according to this economist, include the “largest net-short positions on the S&P 500 in recent history,” the aggressive buying of call options as suggested by the most elevated put-call ratio since January and the fact that 95% of stocks are now trading above their displaced moving average.

The pricing of an economic recovery is subject to the current uncertainty.

Roberts said he expects coronavirus cases to “rise sharply following Memorial Day celebrations and recent crowded protests,” which leads him to think that the “risk of disappointment has risen.”

Morgan Stanley tops

Last week’s top agent was Morgan Stanley with six deals totaling $72 million, a 33.6% share. It was followed by UBS and BMO Capital Markets.

The No. 1 issuer was Bank of Montreal with its $51.7 million deal.

Barclays Bank plc was the top issuer during the previous week. It also tops the list for the year with $4.42 billion in 922 deals.

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