Structured products issuance $865 million for week boosted by year’s top deal of $450 million

By Emma Trincal

New York, Sept. 27 – Structured products agents priced $865 million in 133 deals last week, but more than half of this came from a jumbo synthetic convertible offering, which was the top offering in size for the year, according to preliminary data compiled by Prospect News.

Number one

The deal was from GS Finance Corp., which issued $450 million of 4% fixed-rate equity-linked notes due Sept. 28, 2026 tied to Palo Alto Networks, Inc. The notes priced at 110.98% of par for $499.41 million of proceeds. The complex payoff was based on a “make-whole event,” involving a variety of corporate changes in ownership or capital distribution.

About a month ago, Barclays Bank plc sold $450 million 4% synthetic convertible notes linked to Alphabet Inc. The notes priced at 108.9% of par for $490.05 million in proceeds.

“These are not retail deals. They are corporate solutions,” said a structurer.

Synthetics, ‘magnificent’

This year has seen the pricing of six synthetic convertible offerings like those two. Ranging from $65 million to $450 million in size, those deals amounted to a total notional of $1.3 billion, which represents 14% of the $9.02 billion stock-linked issuance volume. That’s six deals out of a 3,043 total for the year.

The names are in decreasing deal size: Palo Alto Networks, Alphabet, Walt Disney Co., Cummins Inc., Halliburton Co. and L3Harris Technologies Inc. Citigroup Global Markets Holdings Inc. and Morgan Stanley Finance LLC are the two other issuers having come up with synthetic convertible issues this year.

Separately, the so-called “Magnificent Seven” – Amazon.com; Tesla, Alphabet, Microsoft, Apple and Nvidia and Meta Platform – represent $3.76 billion in 954 deals, or 42% of the total stock tally, which is nearly one out of three deals.

Concentration risk

This concentration around a small group of underlying stocks reflects in part what has been driving the equity market rally this year. It may also render stock-linked issuance more dependent on market conditions and risk appetite.

The tally for single stock underliers has modestly declined by 5.4% from $9.53 billion last year.

But other factors may play out, especially when it comes to less glamorous stocks and without considering the massive hybrid convertible deals.

“Cash, short-term fixed income, and other low-risk alternatives paid nearly nothing. Now it is quite easy for ordinary investors to earn 4-5% interest on these products. Quite frankly, that compares quite well on a risk-adjusted basis to the average stock,” said Interactive Brokers chief strategist Steve Sosnick.

Rate fears

The stock market sold off last week in reaction to a hawkish Federal Reserve’s announcement. Rates were kept unchanged but more hikes should be expected soon.

The Nasdaq tumbled 3.9% and the S&P 500 index lost nearly 3%. Meanwhile rates continued to rise, with the 10-year Treasury note yield rising to 4.5%, a level not seen since 2007. On Wednesday, the 10-year note yielded 4.64%.

“Nobody knows where rates are going. But the probability of rates being higher for longer is now greater than it was two months ago,” the structurer said.

“It bodes well for structured notes. Their volume is high, and it will increase if rates continue to be elevated. For the industry, it’s a very good thing.”

Payoff diversification

Issuance volume this year is flat compared to last year, according to the preliminary data. But given the gaps between the pricing of deals and their filing on the Securities and Exchange Commission website, the trend is almost certainly up. The year-to-date tally through Sept. 22 was $67.8 billion in 15,915 deals versus $68.12 billion in 21,088 offerings during the same time last year.

One of the benefits of higher rates for the structured notes market is the ability for issuers to offer a more diversified supply of products, this structurer said.

“When rates are higher, it gives you much more funding to play with. You can do a lot of downside protection. You can diversify the payoffs quite a bit. You can create all kinds of deals, not just the monetization of volatility,” he said.

The monetization of volatility usually produces income products, which short volatility to generate a premium, which in turns generate a coupon.

“When rates are low, you have a negative vega. You’re limited to autocalls and capped buffered notes,” he said.

The vega value of an option reflects how much its price will change for every percentage point the implied volatility of the underlying security increases by.

“With higher rates, you can be long volatility. You can uncap, you can offer deeper levels of protection,” he said.

Pricing will impact demand and volume as well.

“I’m not saying we’ll see fewer autocalls. People are used to it. Autocalls are not going anywhere,” he said.

“But you’ll have more choice and more payoffs, which should boost the overall volume.”

Protection for bears

Full principal-protection, however, is not as common as it may be expected, according to the data, which encompasses notes only. Full principal-protection is much more widespread in the structured CD space than in the notes market, according to sources.

With notes, the principal-protection often comes with a bearish tilt.

This month for instance, JPMorgan Chase Financial Co. LLC and GS Finance have priced notes with knock-out barriers favoring a moderately bearish outlook. If the barrier (or barriers) is breached at any time, investors receive only par or a rebate, depending on the structure. Participation is only offered if the option never gets knocked out.

Emerging asset class

Another structuring trend seen recently is the use of futures indexes on the S&P as opposed to the index itself.

As previously reported, GS Finance and BNP Paribas have recently printed notes tied to the S&P 500 Futures Excess Return index.

But another futures underlying index, which launched last year, has been used for the first time this month.

GF Finance priced a pair of five-year autocallable note offerings tied to the S&P 500 Futures Volatility Plus Daily Risk Control index on Sept. 19 and Sept. 22.

The first note pays an 8.5% contingent coupon on a monthly observation date based on a 75% coupon barrier. There is a one-year no-call and a 15% buffer at maturity. The second one, a snowball, offers a call premium of 9.5% above par stepping up by 25 basis points every quarter. At maturity, a set of three strikes will generate three different outcomes, which are a 47% digital (above 88%); par (from 85% to 88%) and if below 85%, losses minus the 15% buffer.

Hedging dividend risk

“The S&P 500 futures index and the S&P 500 Futures Volatility Plus Daily Risk Control are two different indices,” the structurer said.

But the main concept behind the use of futures was to reduce hedging risk for the issuer, he noted.

“When an issuer writes a note, they want to hedge themselves in the market. For that they have to take a dividend risk. Linking a note to a futures index is one way to hedge. Futures are hedgeable because they don’t price the dividend,” he explained.

The concern over dividend risk emerged when in the middle of the year 2020 several corporations cut their dividends triggering losses among note issuers, he said.

“French banks especially took a lot of risk and got hammered.

“The risk departments of the banks went to the derivatives desks and said: no more.”

This led to the creation of decrement indices, which substitute the price return with the total return minus a fixed rate.

“The synthetic dividend is known, fixed and predictable. You take out the risk,” he said.

The use of the S&P 500 futures index and other related futures indexes is just another way for banks to mitigate dividend risk.

Biotech bid

The biotech sector was celebrated last week and earlier this month. Citigroup, JPMorgan and Barclays priced a number of medium-size autocallable offerings on the SPDR S&P Biotechnology ETF at different times.

Citigroup sold this month five offerings tied to this ETF ranging from $10 to $15 million for a total of $57 million.

Barclays last week brought to market a $10 million deal on the same underlier, which Morgan Stanley distributed.

JPMorgan issued several smaller issues earlier this month.

For last week’s ranking, Goldman Sachs was the top agent with $531 million in nine deals, which included the $450 million behemoth.

It was followed by Morgan Stanley and UBS.

GS Finance Corp. was the No. 1 issuer with $532 million in 10 offerings, a 61.6% share.

© 2015 Prospect News.
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