Structured products weekly tally at $482 million amid buoyant rally induced by cooling inflation

By Emma Trincal

New York, July 19 – Equity markets finished last week strongly higher after the release of encouraging inflation numbers. Meanwhile, structured products agents priced $482 million in 101 deals, according to preliminary data compiled by Prospect News. Overall, the impact of surging stock prices is a mixed bag for structured notes issuance as it impedes pricing while freeing up proceeds, sources said.

The CPI increased 3% for the 12 months ending June, the smallest 12-month increase since March 2021, according to the Bureau of Labor Statistics.

In reaction, the Nasdaq jumped 3.3% last week. It is 35% higher for the year.

CPI relief

“The latest inflation data last week was bullish for stocks, and yields came down. People think inflation is under control and they expect the Fed to stop raising rates any time soon,” said Mark Dueholm, chief fixed-income trader at Landolt Securities.

“But this optimism relies on the June CPI figures, which to me are misleading because you’re comparing it from June 2022 when gas prices peaked as a result of the Russian invasion of Ukraine.”

Dueholm concluded with a contrarian view.

“My personal opinion is that the market continues to underestimate the Fed’s determination to raise rates further. I think inflation will continue to rise,” he said.

Rolling over

Higer stock prices, lower volatility and declining yields are not the best recipe for pricing structured notes, especially for short-volatility products, such as income notes, a sellsider said.

“It doesn’t help getting coupons but we’re seeing a lot of opportunities for growth products. There is a shift happening especially toward uncapped leveraged notes. People anticipate a soft landing, and, in this case, there will be a lot of upside in equities,” he said.

Yet last week’s structure breakdown showed an overwhelming amount of autocallable and callable products (issuer calls) making for 78% of total sales. But pricing conditions may not have been the main driver.

“We’re seeing a lot of increase in income notes. They haven’t traded yet, but they will in the coming weeks,” this sellsider said.

Issuer calls

“Issuers are calling right now. It’s the perfect market environment for them to make those decisions,” he said.

This situation contrasts with last year when the bear market put the brakes on call activity.

“Now notes are getting called and when they get called, they typically go into other income products, which pushes volume higher,” he said.

Issuers will exercise calls based on interest rates and equity prices, he noted.

“The stock market has been going up and interest rates have stabilized so calls make sense,” he said.

When a callable note has gained value due to an equity rally, issuers will buy it back to sell it at a premium, he explained.

“Issuers look at the embedded options and the value of the bond. If the value is more than the call price, they’ll call. All this depends on where rates were on the strike date,” he said.

“If a stock market is flat and interest rates are up, the bond portion doesn’t increase in value. Options stay the same. The issuer won’t call.

“But right now, rates are slightly lower, and the equity market is on a tear. We’re definitely getting more money in.”

Dueholm agreed.

“Issuers are calling because these notes are tied to stock indices, and some are way in the money. You started with a 40% protection. Now you have a 50% protection,” said Dueholm.

“If an issuer sold a note paying an 8.65% coupon with a 50% protection and they can now pay 7% with a 40% protection, they are going to call for sure.”

Autocalls versus callables

But the bull market does not help extract high premium. With a more challenging pricing environment, issuers are using traditional tools to boost yields. Employing discretionary rather than automatic calls is one of them.

“Issuer calls have become more popular among investors because you get such better coupons,” the sellsider said.

“Some advisers don’t like them because of the uncertainty. But platforms like Simon and Halo help them track the price easily and you can get a sense of whether an issuer is going to call.”

For the month through Friday, issuers priced $259 million of autocallable notes versus $245 million in callable products. While the difference in total notional sales is negligible, the deal count is not. The tally for autocallables was 82 versus 40 for callable notes, revealing an average deal size twice as high for the latter.

Two big deals

The two largest income deals to price last week were both issuer call products. They were also the top offerings of the month.

Morgan Stanley Finance LLC sold $67.69 million of one-year 9.7% callable fixed income securities tied to the worst performing of the Nasdaq-100 index, the S&P 500 index and the Russell 2000 index.

Interest will be paid monthly. The notes will be callable at par plus the coupon on any monthly redemption date after six months. The principal repayment barrier at maturity is 70% observed point-to-point. Morgan Stanley & Co. LLC is the agent. The fee is 0.25%.

On the same day, Citigroup Global Markets Holdings Inc. priced $39.38 million of 12.022% callable equity linked securities with the same maturity date and the same underliers for the worst-of exposure.

The barrier level was identical. But the observation was daily (American barrier), adding risk, hence premium to the structure.

Citigroup Global Markets Inc. is the agent. The fee is 0.45%.

American barrier, worst-of

Dueholm explained the gap in yield between two deals seemingly identical.

“You can see how the American barrier is boosting your coupon. You’re taking risks because you’re subject to risk every single day. But you’re getting compensated a lot with that 12% coupon,” he said.

The sellsider said that the two deals were customized for a particular client.

“I am aware of an RIA who always buys these deals and they’re always large. They’re not unusual,” he said.

Issuer calls, American barriers, volatile underliers, worst-of, those are some of the structuring techniques used by issuers to overcome the muted volatility levels, which reduce the amount of premium available for coupons.

“We’re seeing a lot of worst-of in the market right now. Stocks are rallying and volatility is low,” the sellsider said.

“Up until a couple of weeks ago, you could see good deals on single indices. Now as the market is going up, coupons tend to go down.”

Another benefit of worst-of pricing is the increased premium obtained from dispersion, the sellsider said.

“As the market rallies, correlations between indices are dropping. It helps pricing a lot too,” the sellsider said.

Single stocks

Another potential trend to emerge if the rally endures could be a fresh bid on single-stock linked notes.

However, this trend would only develop if advisers felt confident enough with single stock risk. Right now, the bid is on big tech stocks, which have scored significant returns. On Wednesday, the Nasdaq hit its highest level since April 2022. It has gained more than 43% since its October low.

Stock-linked notes issuance made for 19% of last week’s total issuance, which was greater than the 11% average market share seen so far this year.

JPMorgan Chase Financial Co. LLC priced the top single-stock offering with $16.36 million of three-year trigger autocallable notes linked to Alphabet Inc.

The notes will pay a contingent quarterly coupon of 9% per year based on a coupon barrier of 62.25%. The notes are automatically called after six months if the price is at or above its initial level on a quarterly observation. The barrier at maturity is 62.25%. UBS Financial Services Inc. and J.P. Morgan Securities LLC are the agents.

While even big tech stocks have seen their volatility decrease as the market is up, Alphabet still shows an implied volatility of 33%, well above that of the S&P 500 index, which is 13%.

Issuance volume for the year through July 14 is down 6.9% to $46.61 billion from $50.06 billion.

The number of deals has declined by nearly a third to 10,510 from 15,615.

Citigroup was the top agent last week with $132 million in 19 deals, or 27.4% of the total.

It was followed by UBS and Morgan Stanley.

The No. 1 issuer was Citigroup Global Markets Holdings, which brought to market 18 offerings totaling $131 million, a 27.2% share.

© 2015 Prospect News.
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