Bear market not shutting down structured note sales, at least for now; issuance up 112% for year

By Emma Trincal

New York, March 18 – As the U.S. stock markets fell into bear market territory last week, the structured products market was in full gear. The spread of the coronavirus and an oil price shock on Monday drove stock prices to sharp declines prompting circuit breakers at the open as volatility reached new highs.

Meanwhile volume for the month through March 13 is up nearly 10% to $1.96 billion in just two weeks. The stock market sell-off began Feb. 28.

Last week saw the pricing of $487 million of structured notes in 93 deals, according to preliminary data compiled by Prospect News. These figures will be revised upward as the live data gets recorded with some delays due to the downpour of new offerings. Just for the first week of March, updated figures showed $1.47 billion in sales through 319 deals, a very unusually high notional number for this early part of the month.

Even more telling: issuance volume growth is increasing at nearly unprecedented levels for the year to date. Sales through last Friday reached $16.21 billion, a whopping 112% increase from last year’s $7.64 billion.

The number of deals surged to 4,259 deals from 2,463 deals, up 73%.

Bear market

The Dow Jones industrial average finished the week down 2,680 points, a 10.36% drop for the week. On Monday alone, the index lost more than 2,000 points, its worst day since 2008.

“This market is rapidly changing,” said Matt Rosenberg, head of trading and strategic initiatives at Halo Investing.

But the appetite for income notes is still on in full force.

“Last week we saw even more income deals than usual. But I suspect that with the Dow down 30% and the S&P 28% for the year, more people are going to move into uncapped leveraged notes to capture the upside when things become a little bit more under control.

“A lot of people are getting ready to play a sharp rebound,” he said.

The market share for autocalls last week was 43% compared to 32% for leveraged notes with barriers or buffers. The amount of leveraged structures was higher than usual due to a $90 million leveraged offering, the top issue of the week.

Autocallables for now

It is unlikely that investors will find full protection in the near term at least as long as the bond rally goes on.

In a flight for quality, the 10-year Treasury fell to a new record low at 0.4%. Rates have since rallied to 1.15%.

“With rates down, full principal-protection deals aren’t that attractive,” he said.

“Given how much we lost, I don’t think many people are going to be jumping into full principal-protection anyway.”

Rosenberg sees the use of autocallable notes as a tool allowing investors to navigate the new bear market and the unpredictability of the new coronavirus pandemic.

As volatility levels are off-the-chart, investors get better coupon or/and deeper barriers, he said.

“People looking for income will take a 6% or 7% all day. As soon as the market rebounds, the notes will get called and what we call reinvestment risk will actually turn out to be a reinvestment opportunity. It will allow people to switch a portion of the portfolio from a fixed-income generating product to a long exposure via growth notes.

“The crazy volatility is a good call to action. You get the protection through an autocall and use it as a temporary stop gap before switching back to leverage.”

Holding hands

This is not to say decisions are made smoothly and quickly when the market can swing up or down by more than 1,000 points a day.

“My clients like everyone else’s clients are scared to death. They don’t know what to do. We spend most of our time talking to them,” a buysider said.

With days like Thursday when the Dow dropped 2,300 points, it’s not hard for investors to panic.

“Advisers are spending a lot of time on the phone with their clients, telling them it’s going to be OK. When you’re near retirement and losing clips of money every day, it’s not easy. It keeps advisers very busy,” said Rosenberg.

Tom Balcom, founder of 1650 Wealth Management, told his clients in a letter that what is almost unprecedented is the speed of the market drop. From its all-time high in Feb. 19, it took the S&P only 22 days to fall into a bear market, he noted.

“If we would have told you on February 19th that the stock market would enter a bear market in less than one month, you would have thought we were absolutely crazy. Unfortunately, fear related to Covid-19 has led to the sudden and sharp pullback in the stock market.”

Rolling

Balcom is considering rolling some of his clients’ existing structured notes. He said he has been in contact with various issuers, citing Citigroup, Morgan Stanley, Goldman Sachs among others, regarding the pricing of his client’s market-linked notes.

“If it makes financial sense, we will sell one or more notes and roll them into new notes to take advantage of the currently elevated volatility levels,” he said.

He is educating his clients about the liquidity potential of structured notes.

“Even though most notes are three years in duration, you are not ‘locked’ into these positions until maturity.

“These notes are priced daily in what is called ‘marked-to-market.’ While it may make financial sense to continue holding some of these notes, it may be beneficial to sell and roll one or more notes prior to their maturity date.”

Scary statements

Mike Kalscheur, financial adviser at Castle Wealth Advisors, admits that clients get nervous when reading their statements.

“It’s very difficult to explain to clients that what they see in their Schwab statements are just day-to-day losses.

“The price of the notes can’t be reflected in these day-to-day changes. When they see the market dropping like a rock, we hear them say a lot: ‘oh Gosh, get me out.’”

When clients want to sell, banks may bid on the note, but there is a haircut, he noted.

“We don’t usually do that. We’re not traders. We’re trying to ride this thing out. It has always been our philosophy.”

To be on the cautious side, Kalscheur said his firm has decided to cap the amount of structured notes in IRA accounts for clients near the age of 70 as they have to take required distributions at the age of 70½.

“The market tries to find a floor. This extreme volatility won’t last. Ultimately, long-term investors will be rewarded, which is why we like to buy long-term structured notes.”

Balcom warned his clients against panic-selling.

“It often takes less than two years to recover from a bear market,” he said.

“If an investor were to panic and invest in a 10-year Treasury note, which is currently yielding 0.85%, instead of staying the course, it would take 29 years to recover from the recent all-time high.”

Top deals

Last week’s top deal was Citigroup Global Markets Holdings Inc.’s $90 million of five-year geared buffer securities linked to the S&P 500 index.

The payout at maturity will be par plus 1.5 times any index gain.

Investors will receive par if the index falls by up to 20% and will lose 1.25% per 1% drop beyond 20%.

Citigroup Global Markets Inc. is the agent.

Canadian Imperial Bank of Commerce’s $61.68 million of 17-month digital notes linked to the S&P 500 index was the second top offering.

If the index return is greater than or equal to negative 10%, the payout at maturity will be par plus 14.8%. Otherwise, investors will lose 1.1111% for every 1% that the index declines beyond 10%.

CIBC World Markets Corp. is the agent.

Coincidentally both offerings featured geared buffers, a simple way to improve the economics of a note.

Last week’s top agent was UBS with $170 million sold in 74 deals, about 35% of the total.

It was followed by Citigroup and CIBC.

The No. 1 issuer was Citigroup Global Markets Holdings with $145 million in seven deals, a 29.77% share.

“A lot of people are getting ready to play a sharp rebound.” – Matt Rosenberg, head of trading and strategic initiatives at Halo Investing

“My clients like everyone else’s clients are scared to death. They don’t know what to do. We spend most of our time talking to them.” – A buysider

“The market tries to find a floor. This extreme volatility won’t last. Ultimately, long-term investors will be rewarded, which is why we like to buy long-term structured notes.” – Mike Kalscheur, financial adviser at Castle Wealth Advisors

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.