Structured products issuance hits $50 billion year to date as equities set new highs

By Emma Trincal

New York, Aug. 11 – Sales of structured notes in the United States continue to climb as does the stock market posting new record highs last week.

While the Delta variant of Covid-19 is spreading and fears of an economic slowdown are mounting, inflation remains a threat, which has investors confused about the market outlook hesitating between a reflation and deflation scenario.

Despite fears of the Federal Reserve potentially tapering down the road, a strong set of earnings and a robust job report on Friday reassured investors about the prospects of an economic rebound, which naturally led to new market highs.

$50 billion year to date

Structured notes issuance volume was up 17.2% this year through Aug. 6 (last Friday), to $50 billion from $42.67 billion a year ago, according to preliminary data compiled by Prospect News.

It is the first time since Prospect News began compiling data in 2004 that sales have reached the $50 billion milestone for this period – approximately the first seven months of any given year. The closest year behind this tally was in 2008 with $39.46 billion. The year 2017 and 2018 were the next best years for the same period. But they also fell far behind with $32 billion and $36 billion, respectively.

Growth factors

“This record volume doesn’t surprise me at all,” a structured notes broker said.

Many factors contribute to this picture, he added.

“First, you see divergences among investors in their market outlook. Investing in products that can customize your view is going to be compelling. It’s not one-size-fits-all.

“Second, people are reevaluating their allocations to fixed income. Bonds are not providing much of anything. Because structured products can generate above-average yields, this environment gives our industry the opportunity to play a bigger role.

“In addition to that, technology has really helped scale up our business. Advisors can effortlessly customize their notes, relying less and less on calendar deals. That’s definitely appealing.”

Issuers benefit from technology as well, he noted.

“They’ve seen their processes becoming much more efficient. They can generate many deals without incurring extra costs. Issuers are now machines. They manufacture products based on investors’ needs.”

Finally, technology has been critical to price discovery, he said.

“Automated multi-issuer platforms allow investors to better understand how the notes are priced and structured.

“It really gives first-time investors the confidence to buy and existing ones the drive to buy more,” he said.

Structured notes also allow investors to gain a more defensive exposure to a “hot” equity market that some are saying has become overbought and speculative.

Bears looming

A growing number of analysts have recently expressed concern about a market hitting new highs on a weekly, sometimes daily basis.

The Fed is often viewed as the culprit.

“The main effect of Fed easing is simply to create a pile of zero-interest hot potatoes that someone in the economy has to hold at every moment in time,” said John Hussman, president of Hussman Investment Trust, in a recent research note.

Stressing the risk of the Fed being “behind the curve,” he added: “It may be useful to examine how that pile of zero interest money can encourage speculation, and also the conditions when Fed easing can be ineffective or even useless in ‘supporting’ the market.”

Expecting the unexpected

In the meantime, zero-interest rates are “supporting” not just the stock market but also the record sales of autocalls designed as an opportunistic alternative to low-yielding bonds, the structured products broker said.

Still, investors are facing uncertainty on several fronts such as the direction of interest rates, the role of inflation in forcing the Fed to tighten its monetary policy and the impact of a potential tapering on stock prices.

“The good times can’t keep on rolling. We’re seeing major bubbles. A lot of money is moving to very illiquid assets, private equity essentially. On a smaller scale, structured products are part of this trend too,” said Ferenc Sanderson, a hedge fund consultant.

“A crash is always prompted by something that’s unexpected and usually a shock, something people didn’t account for,” he said.

Plummeting oil prices ahead of the emergence of the pandemic last year was an example. The drop in oil prices, which started in December 2019, preceded the coronavirus-induced bear market of February/March.

As the Fed has pushed real interest rates into negative territory, investors’ preoccupation with yield has never been so great, he noted, contributing to the success of new products, such as structured notes or riskier asset classes to generate acceptable rates of returns.

“There’s just so much liquidity in the system. People are desperate for yield. So long as this policy remains in place, the rush for yield will continue,” he said.

This is not new.

“The Fed’s policy has been going on for a long time. But there’s not just the Fed. It’s a global phenomenon. In some countries like Germany and Japan, banks are struggling to give any positive interest rates to savers.”

He pointed to another risk created by the zero nominal interest rates.

“A lot of institutional investors demand more leverage from their managers. What’s going on with the SPACs bubble is pretty crazy. So yes, there are a lot of red flags out there,” he said.

Positive consequences

How this will pan out for structured products is unclear, the structured notes broker said.

“Some people worry about the Fed tapering, but the monetary stimulus at the same time is making progress. It’s challenging to predict what the outcome is going to be. To me, it’s a positive trend for our industry. We provide higher yields and the downside protection,” he said.

In other words, structured notes offer better alternatives to both stocks and bonds.

Leverage resurging

The first week of August kicked off decently with $397 million in 101 deals, the preliminary data showed.

“It’s too soon to tell what August will be like,” said the broker.

“But we’re now in the dog days of summer. If volume slows, it should pick up after Labor Day.”

As seen recently, leveraged notes are back, and they support the overall volume given their larger size.

Thirteen enhanced return notes offerings were brought to market last week for $102 million. A big chunk of it came from a block trade brought to market by Bank of Nova Scotia with Goldman Sachs & Co. LLC acting as dealer.

The Canadian bank issued $81.76 million of 15-month leveraged notes linked to the Russell 2000 index paying at maturity 3x the index gain, up to a cap of 18.45%. Investors are fully exposed to any losses.

“This is the typical [Accelerated Return Notes] you see from BofA month after month,” the broker said.

“Goldman Sachs as a private bank can distribute the same thing. Copycat deals are very common and why not? If a bank sells a note successfully, it can be repeated over and over by other players in a similar way.”

Autocallables

Autocallables remained the dominant structure last week with 53% of total sales for $211 million. As expected, those income products are generated by a greater number of deals than leveraged notes. More than eight out of 10 offerings fell into the autocall category.

Last week’s stocks, including single stocks and worst-of, made for a quarter of total sales with three-quarters of the number of deals. It was the reverse for ETF and index deals combined: one deal out of four accounted for three-quarters of total issuance.

Big ETF play

One large ETF deal was Citigroup Global Markets Holdings Inc.’s $39.43 million of three-year autocallables on the Invesco QQQ Trust, series 1 and the iShares Russell 2000 Value ETF.

The notes pay a quarterly contingent coupon at an annualized rate of 6.1% if each fund closes at or above its coupon barrier, 70% of its initial value. The notes are automatically callable after six months. The downside threshold is at 70%.

Citigroup Global Markets Inc. and UBS Financial Services Inc. are the agents.

Among worst-of deals on stocks, financials and tech stocks prevailed. Financial ETFs were the top performing equity sector last week with a 2.25% return compared to 0.9% for the S&P 500 index.

The most commonly used financial stocks seen last week were American Express Co., Mastercard Inc., Visa Inc. Paypal Holdings, Inc. Capital One Financial Corp., Discover Financial Services and Prudential Financial, Inc. The big banks were missing in this picture.

The tech names were the usual suspects: Apple Inc., Amazon.com, Inc., Facebook, Inc., Microsoft Corp. and Alphabet Inc.

ICE swap digital

Also notable was the pricing of an interest rates-linked notes offering with FX exposure, which JPMorgan Chase Financial Co. LLC priced for $9.3 million.

The one-year digital notes are linked to the 10-year U.S. dollar ICE swap rate. If the swap rate finishes at or above its initial value or falls by up to 23.1%, the payout at maturity will be par plus a contingent digital return of 10%.

If the rate falls by more than 23.1%, investors will lose 1.30039% for every 1% of decline below the buffer.

The top agent last week was UBS with $150 million in 71 deals, or 37.8% of the total.

It was followed by Goldman Sachs and JPMorgan.

The No. 1 issuer was Bank of Nova Scotia capturing 27.2% of the shares in two offerings, a total of $108 million.

For the year to date, Barclays Bank plc remained the top issuer with $7.6 billion in 1,265 deals, a 15.2% share.

© 2015 Prospect News.
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