Structured notes see rotation back to tech, bid on stock deals as Fed takes more hawkish stance

By Emma Trincal

New York, June 23 – Structured products agents priced $133 million in 105 deals in the third week of June, according to preliminary data compiled by Prospect News, which will be upgraded upward.

It was a turning point for the market as volatility jumped in reaction to a Federal Open Market Committee meeting, which opened the door to one rate hike next year and a tapering of its bond-buying program. The market tumbled in reaction to the Fed’s change in tone as its previous meeting in March had ruled out any rate increase next year.

Citi’s $62.7 million deal

A recent update for the previous week ending June 11 revealed a high tally of $1.08 billion in 296 deals.

One of those – and the largest one – was Citigroup Global Markets Holdings Inc.’s $62.66 million of trigger callable contingent yield notes with daily coupon observation due Sept. 16, 2024 linked to the worst performing of the MSCI Emerging Markets index, the Russell 2000 index and the S&P 500 index. UBS distributed the deal.

Each quarter, the notes will pay a contingent coupon of 8.5% per annum if each index closes at or above its 70% coupon barrier on each trading day during that quarter.

The notes can be automatically called on any quarter at the initial price trigger level. The barrier at maturity is 60%.

“I think it was a big trade because it appeals to asset allocators. It fits the needs of a wider set of investors,” a sellsider said.

“It’s not the tactical, higher risk typical income product. It may be an income note; it’s still based on three indices you already have exposure to.

“Also, the 40% protection at maturity is compelling.”

Big stock deals

But this deal is not representative of a newer trend showing bigger size deals on single-stock products.

The week prior to last week offered a few examples.

JPMorgan Chase Financial Co. LLC for instance priced a pair of three-year autocallable note offerings, one for $38.41 million tied to ViacomCBS Inc., the other for $32.76 million on Intel Corp.

Additionally, GS Finance Corp. sold $32.88 million in three-year autocallable notes on Alibaba Group Holding Ltd.

More stocks, more income

Last week revealed that the proportion of single stocks as a percentage of total sales could equal that of equity indexes. Each of those two asset classes accounted for approximately 40% of the total issued. This distribution may be skewed by incomplete data. But it still contrasts with the year-to-date average of 22% of total volume going to single stocks versus 56% to equity indexes.

As always, investors, given their thirst for yield, favored autocallables over leveraged deals, the former making for 77% of total issuance volume last week versus 12% for the latter.

Complaints on coupons

If investors are increasingly taking more risk through the purchase of single-stock notes, it’s because coupons on indexes have become unappealing, said Jerry Verseput, president of Veripax Wealth Management.

“It’s a tough environment for notes right now,” he said.

“A two-year income note used to give you 9% to 10%. Now the same note will yield 6%.”

The main driver for this coupon compression is macroeconomic in nature, he said.

“There’s so much capital in the system that banks don’t need to pay that much for your money.

“Banks if they issue a three-year or a six-year still need to add that debt to their portfolio. If they don’t need that debt, they don’t need to pay that much in income,” he said.

Structured notes buyers have to adopt a more “narrow approach” when selecting the underlying assets for their products, this adviser said.

“Right now, I divide my portfolio into two groups. I have a 30% bucket in which I put longer term, five- to six-year deep safety notes. I’m lucky if I get 8%. Separately I have a 70% allocation to short-term exposure. I can’t really use broad indexes in there. I have to focus on sector ETFs and individual stocks,” he said.

Issuers’ rationale

The excess of liquidity in the system may impact coupon rates, but not necessarily the issuance pace of the banks, the sellsider said.

“If you believe rates will be higher in the future, you certainly want to issue more now. That would be one factor driving volume this year,” the sellsider said.

“In theory, there isn’t a push to issue more structured products from the banks’ standpoint.

“After all, issuing structured notes adds potential risk on the books. The treasury of a bank doesn’t have a big incentive to issue more.

“And yet, I haven’t seen issuers slowing down really or limiting themselves. It’s not as if the banks had a cap above which they don’t issue anymore.”

One factor that may contribute to lower yields is the erosion of banks’ margins with the decline in long-term rates.

“Banks are not getting paid to lend out money,” he said.

“In those circumstances, they have no choice but to offer lower coupons.”

Vertical vs. horizontal

A more obvious and direct factor behind the lower coupons on indexes and the shift toward single stocks is volatility.

Last week’s Fed bombshell caused the VIX index to climb from 15 on Monday to nearly 21 on Friday.

The quadruple-witching options expiration exacerbated the jump in volatility as well as a hawkish comment from St. Louis Fed president James Bullard on Friday. Yet, sudden and short-lived spikes in the VIX may not necessarily provide better terms, the sellsider said.

“You can’t just have a spike in the VIX for one or two days. You need multiday spikes to see them reflected in the futures contract’s price.

“The six-month out VIX futures contract is significantly lower than the spot VIX price.

“That means that your VIX futures are not that elevated from a hedging perspective to provide much term improvement.

“Investors are seeing worse terms because the market is interpreting volatility moves as very short in time, so it doesn’t impact the options price as much.”

Relief for tech

Signs of the Fed acknowledging inflation and signaling possible actions against it in the near future provided support to technology stock prices, which are inflation sensitive. It may also have contributed to a continued switch from cyclical to tech underliers.

The S&P 500 index fell 1.9% on the week. The Nasdaq was down only 0.3%.

The main culprit was the Fed’s more hawkish tone, which apparently took the stock market by surprise.

Issuers priced a few tech deals of decent sizes for single-stock products. Meanwhile energy and bank names were lacking. A rise in the U.S. dollar hit bank stocks especially hard.

Two tech deals

Barclays Bank plc’s $10 million of two-year snowball notes linked to Alphabet Inc. pay a 9.65% annual rate based on a 90% coupon barrier on a quarterly observation date. The automatic call trigger is at 100% and the principal repayment barrier at maturity, 90%.

Morgan Stanley is the dealer.

Morgan Stanley priced a quasi-identical deal on the behalf of Citigroup Global Markets Holdings. The notes are linked to Amazon.com, Inc. The term is two years and the issue size, $10 million as well. The barrier levels are the same, but the contingent coupon is 10.5%.

Investors however are still betting on an improved economy. Some of the stocks associated with the reflation game seen last week included Boeing Co., Ford Motor Co. and United Airlines Holdings, Inc.

Panic on the Titanic

The bid on growth underliers has been a trend for the past few weeks. It has been a reverse trade from the “rotation” trend which led investors to bet on the economic recovery with value and cyclical names since the end of last year.

The technology sector was especially hit in March during the bond sell-off. But since then, yields have come down and the Nasdaq has regained 16% from its low of the beginning of March.

This back and forth from growth to value and vice-versa is a nothing else but an attempt on the part of investors to squeeze the last returns of an ending bull market, according to bearish portfolio manager Steven Jon Kaplan, founder of True Contrarian Investments.

“Just as in 2007, 2000, 1973, 1929, and during other major bear markets, investors refuse to believe they can lose money,” he said.

“They are mostly foolishly rotating from one sector to another, which is equivalent to upgrading cabins on the Titanic after it has hit an iceberg, rather than heading for the lifeboats.

“Don't be a hero; you won't get extra points for going down with the ship in a blaze of glory.”

Year to date

Agents this year have priced $37 billion through June 18 compared to $34.08 billion during the same period last year, an 8.6% increase. The number of deals has remained stable from 10,164 last year to 10,299 this year.

Updated monthly figures indicate that January and March remained the top months in volume with $8.1 billion and $7.95 billion, respectively. February, April and May followed in decreasing order.

Morgan Stanley is the top agent for the year with $8.9 million in 1,307 deals, or 24% of the total. It is followed by UBS and BofA Securities.

Barclays Bank is the No. 1 issuer with 902 offerings totaling $5.723 billion, a 15.47% share.

© 2015 Prospect News.
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