Structured products tally for month to date $1.73 billion, up from July; rolls seen as driver

By Emma Trincal

New York, Aug. 16 – Agents priced $1.725 billion of structured products so far this month through Aug. 11 in 250 deals, a 39.6% increase from $1.236 billion sold during the same period last month, according to preliminary data compiled by Prospect News.

For the year to date, issuance volume is getting close to being on par with last year. Sales amounted to $55.7 billion through Aug. 11 compared to $56.08 billion last year, a modest 0.68% decline.

These are encouraging results considering that the gap was much greater earlier in the year.

At the end of the first quarter for instance, issuance volume at $23.87 billion was 7.5% lower than the $25.8 billion tally priced the year before.

Rolling over

“The stock market has been up since March. That led to a lot of calls. It’s that simple,” a structurer said.

“At the end of March, the S&P was at 4,000. Now it’s at 4,400 and it peaked at 4,600 in July. It’s a pretty big runup.

“Anything issued going back to early 2022 has probably been called.”

The market hit an all-time high in January 2022 and fell last year, only recovering in October. Last year, the S&P 500 index dropped 19.5% and the Nasdaq-100 index lost a third of its value.

This year’s equity rally pushed the S&P 500 index 15% higher and the Nasdaq climbed 30%.

“If the market stays up, things issued back six months or a year ago are going to start getting called in the next month or two,” said this structurer.

However more risks have emerged this month including a slowing growth in China, a downgrade of the U.S. debt by Fitch Ratings, the threat of more downgrades on banks and signs that inflation is persisting. As a result, the S&P 500 index is down 3.5% for the month.

Bad deals

“Terms are not as good as last year, that’s for sure. When the market rises and volatility comes in, it impacts the coupons. Higher interest rates are helping a little bit but not nearly enough,” the structurer said.

During interviews with Prospect News, several financial advisers have voiced their displeasure with a number of structures or pricing constraints.

Those include the necessity to eliminate the leverage on the upside and extend maturities in order to uncap a note on a single index; shorter notes with no leverage and low caps; autocallable contingent coupon notes with daily observations; snowballs with annualized autocalls but no downside protection; and monthly issuer calls kicking in on the first month.

“The low volatility hurts all kinds of notes but mostly contingent income autocallable notes. That’s all customers selling put options, so you get less premium,” said the structurer.

“Just look at the VIX. In October 2022 it was in the mid-30’s. In the last two months, it’s been around 16 or even lower.”

Income bid still strong

Despite the deteriorated optics, demand for above-average yields continued to draw demand for income-oriented notes.

“When a deal gets called, people tend to roll over. A lot of advisers keep reinvesting in new autocalls,” he said.

To be sure, issuance volume of autocalls is up this year. Sales rose 8.1% to $26.14 billion through Aug. 11 from $24.18 billion last year.

For this structurer, the fact that short-term Treasuries offer yields in excess of 5% is not really a challenge, at least not yet.

“Yes, we’re seeing a little bit more competition from Treasuries and fixed-income. You would guess that it would be a problem. But for now, I’m not seeing this as big of a problem as you would think,” he said.

“I believe it will become an issue if interest rates stay up and the market starts going down again.

“Now we have a lot of autocalls getting priced because we have the benefit of reinvestments. But if reinvestments dry up and the market starts to push people into cash, I can easily see investors saying: I can get a 5% treasury; I don’t need to take equity risk. Then I think it would be a problem.”

PPNs rising

If one structure may benefit from current market conditions, it’s the principal-protected note, also known as PPN.

“That’s what’s working right now. When volatility is down, call options are cheaper. Interest rates are higher so there is also more money to spend on the call options,” he said.

Right now, this structurer sees on his screen 42 upcoming offerings of PPNs for August, not including JPMorgan.

One, for instance, is a five-year BNP Paribas issue on the S&P 500 index with a 100% upside participation capped at 52.25%.

He also mentioned a few offerings from Morgan Stanley and Barclays.

“Market-linked CDs are also in high demand right now. Right now, I see 55 of them coming up for the rest of the month,” he said.

Sector ETFs

Single stock issuance volume remained subdued last week making for only 7% of sales versus a 12% average for the year to date. The market share for this asset class last year was 14.5%.

Exchange-traded funds on the other hand continued to grow. The tally for this underlying asset class rose 51% this year to $4.74 billion from $3.14 billion a year ago. Their market share year over year is up to 8.5% from 5.6%.

As a means to extract more premium, banks lately have included in their worst of offerings sector or region ETFs alongside broadly diversified index funds.

Last week for instance JPMorgan Chase Financial Co. LLC priced $24.05 million of two-year callable notes linked to the Nasdaq-100 Technology Sector index, Russell 2000 index and S&P 500 Equal Weight index.

The notes paid a monthly 9.5% annualized contingent coupon with memory based on a 70% coupon barrier.

Aside from the two main energy ETFs – the SPDR S&P Oil & Gas Exploration & Production ETF and the Energy Select Sector SPDR Fund – issuers have used other sector funds such as the Industrial Select Sector SPDR Fund and the Health Care Select Sector SPDR Fund.

The Invesco S&P 500 Equal Weight ETF remained popular to counter the heavy weight of six of the top stocks in the S&P 500 index, which make for more than 20% of the index’s market capitalization. Those are Microsoft Corp., Amazon.com Inc., Nvidia Corp., Alphabet Inc., Meta Platforms Inc. and Tesla Inc.

World, Treasuries, banks

Other less common ETFs such as the iShares MSCI ACWI ETF were employed as well as iShares 20+ Year Treasury Bond ETF used by Royal Bank of Canada in a small fixed-income note bearing a 9% coupon.

The use of this long-term Treasury fund ETF has been rare. Only 22 deals totaling $65 million have employed this ETF as a sole underlier since 2004 when Prospect News began to collect structured notes data.

One ETF, the SPDR S&P Regional Banking ETF, listed under the ticker “KRE,” could gain traction as it did after the banking turmoil in March, according to a market participant.

That’s because Moody’s Investors Service downgraded the credit ratings of several small and mid-sized U.S. banks last week, warning it may also cut the ratings of bigger lenders.

“I would expect people to play KRE in the coming month. Taking a contrarian position on those banks makes sense but you don’t want to do it delta one,” this market participant said.

“Spreads narrowed for banks. Regional banks have to pay 5.5% on their deposits versus 0.5% a year ago. And their loans remain at 5.5% so there is no spread. The majority of regional banks borrow short-term and lend long-term for 15 to 20 years. They now have a lot of risk on their balance sheet.”

Using a diversified ETF in a note versus bank stocks may be a reasonable way to play the sector, he added.

About $100 million of notes tied to the SPDR S&P Regional Banking ETF as a single underlying have been priced this year in 33 deals. When including worst-of, a total of nearly $190 million has hit the market.

Issuance picked up between May and July, when the ETF rebounded. The delay between the March banking crisis and the accelerated bid starting in May revealed that the appetite for contrarian bets among structured notes buyers is not widespread.

Bond bears

Investors last week continued to struggle with inflation fears. While the release of the Consumer Price index on Thursday revealed a moderate rise in year-over-year inflation, the Producer Price index, which came up the next day, showed a higher-than-expected increase in wholesale prices in July.

Yields rose as investors anticipated more inflation and stock prices fell on the fear that the Federal Reserve may have to hike rates further.

As a sign that many continue to bet on higher interest rates, fixed-to-floating notes are remaining popular. The latest example was last week’s Citigroup Global Markets Holdings Inc. $50 million of 13-month fixed-to-floating notes linked to the one-year U.S. Dollar SOFR ICE swap rate. The interest rate will be 7.5% for the first three months. After that, the interest rate will be equal to the one-year U.S. Dollar SOFR ICE swap rate plus 22.5 basis points.

The top agent last week was JPMorgan with $99 million in 19 deals, or 29.1% of the total.

It was followed by Citigroup and Barclays.

The No. 1 issuer was JPMorgan Chase Financial, which brought to market 18 offerings totaling $89 million, a 26.15% share.

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