Structured products sales year to date down 21% from year ago; volume trending upward

By Emma Trincal

New York, April 12 – Structured products agents priced $20.94 billion in 4,061 deals in the first quarter, an 18.8% decline from last year’ s $25.79 billion in 7,699 offerings. But sales have been increasing steadily each month, according to preliminary data compiled by Prospect News.

March was the best month of this first quarter with 1,394 deals totaling $7.42 billion, ahead of $7.05 billion in February and $6.47 billion in January.

March shines

“We definitely noticed a big uptick in secondary activity last month. People who owned paper with Credit Suisse were liquidating and reinvested with other issuers,” said Brady Beals, director, sales and product origination at Luma Financial Technologies.

Another factor, he said, was the volatility spike seen in March as a result of the failure of Silicon Valley Bank as well as Credit Suisse and the overall stress among regional banks.

During a sell-off on March 13, the VIX index surged above 30, its highest-level year to date but still well below its 52-week high of 36.64 in May.

“Volatility definitely created an opportunity,” said Beals.

Barclays’ gift

He pointed to another lesser-known factor, which helped boost last month’s sales.

“September 2022 was a good issuance month. Barclays’ recission offer freed up a lot of liquidity that got reinvested at that time,” he said.

Notes with a six-month no-call, which were issued in September from Barclays’ proceeds, were called in March because the market has been up since September, he explained.

“We saw a pretty decent call activity last month.”

On Aug. 1, Barclays Bank plc began a rescission offer of about $17.6 billion of securities issued in excess of amounts registered under its U.S. shelf registration statements. The securities included $14.8 billion of structured notes with the rest in exchange-traded notes. The buyback period ended Sept. 12.

While the operational error created significant losses for the bank, it was a positive development for structured notes issuance. September ended up being the best month of 2022 with more than $10 billion versus a $7.7 billion monthly average for that year.

Rates comeback

Another factor driving business was the big push in rate products, notably sales of fixed-to-floating rate notes hitting the market in February and March.

In January, the tally of rate-linked products amounted to $319 million in 10 deals, or 4.9% of total volume.

By February and March, it rose to $1.14 billion in 19 deals and $1.15 billion in 22 deals, respectively. Those amounts made for approximately 16% of the total for each month, according to the data.

Prospect News in its interest rate category does not include lightly structured products, such as step-up notes, fixed-to-floating rate notes and capped floaters with no underliers or tied to the SOFR. But it does include notes linked to U.S. dollar SOFR ICE swap rates.

“We noticed a jump in rate deals,” said Beals.

“I don’t know if it started in February, but we’ve definitely seen that trend since last year.

“It reflected more creativity in general and also more conviction about the direction of interest rates.”

There were eight offerings in excess of $75 million in size last month, which accounted for $890 million. Out of this, seven deals were fixed-to-floating rate notes totaling $776 million. Their sizes ranged from $75 million to $150 million.

Goldman Sachs Group, Inc. priced the top one with $150 million of three-year fixed- and floating-rate notes paying a 6% annual rate for the first year followed by a variable rate equal the two-year U.S. Dollar SOFR ICE swap rate plus 90 basis points, subject to a floor of 0.5%. The payout at maturity is par.

Royal Bank of Canada priced the second largest one, a two-year fixed-to-floating deal tied to the two-year U.S. Dollar SOFR ICE swap rate also paying a 6% fixed coupon but for six months, then a floating rate of 90 bps over the swap rate with a floor of 0.5%.

Another $400 million of fixed-to-floating rate notes on the two-year ICE swap rate hit the market in eight deals of $50 million each. The issuers were Goldman Sachs Group, Bank of Nova Scotia, JPMorgan Chase Financial Co. LLC and Citigroup Global Markets Holdings Inc.

On the equity side, the largest trades last month came from digital deals.

JPMorgan Chase Financial issued $113.89 million of digital notes due Nov. 5, 2024 linked to the S&P 500 index. If the index finishes above 90%, the payout is 16.8%. The 10% buffer is geared.

Natural PPNs vs. algos

One structural trend seen this year as a result of higher interest rates was the more visible presence of principal-protected notes (PPNs) tied to equity assets. Yet, sales of equity notes providing 95% to 100% in principal-protection have actually dropped this year.

One reason is the lesser use of volatility control underliers that used to be the engine of these structures. A breakdown between pure equity benchmarks and volatility target indexes indicates a significant drop in the use of those algorithm indexes designed by firms to help price full principal protection by lowering and capping volatility.

PPNs tied to vol control underliers fell from $749 million last year to $78 million this year.

Examples of such indexes include Citi Dynamic Asset Selector 5 Excess Return index, the GS Momentum Builder Focus ER index, the J.P. Morgan Efficiente Plus DS 5 index, the J.P. Morgan Large-Cap Dynamic Blend 5 index and the S&P 500 Daily Risk Control 5% USD Excess Return index.

The trend did not surprise Beals.

“In a low interest rates environment issuers struggled to provide PPNs. Now that rates are higher, they have the flexibility to use pure equity plays,” he said.

Principal-protected notes are built on zero-coupon. As a result, their pricing benefits from higher interest rates.

“Those volatility target underliers are complex. There will always be a preference for more ubiquitous underlying that people understand. Given the choice, investors are likely to prefer a capped principal-protected note on the S&P than anything linked to a volatility target index without a cap,” he said.

“Those complex algorithms served a purpose in a much lower interest rate environment. For the banks it was a way to at least offer principal-protection on equity.”

Some of the one-to-one equity-linked PPNs have relatively low caps, he noted.

“But for some buyers it doesn’t matter. As long as the cap is above the coupons of corporates or CDs, they’re fine. They use those notes as bond substitutes,” he said.

A trader agreed that volatility control PPNs have never been an easy sale.

“We used to see a ton of those proprietary indexes, especially from Citi, JPMorgan, Morgan Stanley,” he said.

“Those big banks came out with their own proprietary indices and used them almost exclusively to price principal protected notes.

“But the problem is that advisers don’t like it very much. It’s hard to explain to customers. And those indices don’t have long track records. It makes it really difficult.”

Phoenix with memory

Another trend in the callable universe is the slight decrease in snowballs both in volume and deal count. Those products have the autocall and coupon triggers placed at par. The call premium is cumulative.

Snowballs last year amounted to $418 million, or 4.4% of total sales. Their notional size this year has dropped to $200 million, a 2.7% share, according to the data.

Anecdotally, more traditional Phoenix autocalls have recently shown “memory” features. The coupon barrier is below the 100% call threshold. But as in snowballs, unpaid coupons can be collected later.

“I think issuers have been more creative in trying to mimic some of the advantages of snowballs. We see a drop in the issuance of those products. It probably reflects the choppiness of this market with people being a little less bullish,” he said.

Buyers of snowballs can only get paid if the market is up.

Lookback is the future

Beals said he found “lookback” structures increasingly popular among some of his clients.

The initial value is set at the lowest price during a lookback period, which lately has been one to three months, he said.

The longer the lookback period, the better for the more cautious investor. But shorter periods help increase the call premium.

“That’s the tradeoff,” he said.

He gave the example of a four-year worst-of note he recently priced comparing the one-month and the three-month lookbacks.

The underliers are the Dow Jones industrial average, the S&P 500 index and the Russell 2000 index. Investors benefited from a 20% geared buffer on the downside. After one year, the note may be automatically called just once. If not called, the note pays at maturity two-times the worst-of gain.

The call premium was set at 17% for the one-month lookback but had to drop to 13% for the three-month.

The top agent for the first quarter is BofA Securities with $2.92 billion in 331 deals, or 13.92% of the total.

It was followed by Citigroup and Morgan Stanley.

The top issuer was Citigroup Global Markets Holdings with $2.74 billion in 544 deals, a 13% share.

© 2015 Prospect News.
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