Sales drop 62% to $415 million amid flight into deals with barriers, buffers, broad indexes

By Emma Trincal

New York, Aug. 24 - Issuance tumbled last week as investors flew to equity indexes and safer structures incorporating barriers or buffers.

At the same time, the surge in volatility created new opportunities for what some saw as better-priced deals.

Sales of non-exchange-traded notes posted almost a two-thirds decline in the week ended Friday. They fell 62% to $415 million, according to data compiled by Prospect News.

But the decrease is based on the comparison with an exceptionally busy week as agents brought to market more than $1 billion of notes during the second week of August.

In addition, the Securities and Exchange Commission temporarily shut down its website on Tuesday due to the East Coast earthquake, which may have reduced the number of deals recorded for pricing last week.

Up for month, year

Sales totaled $1.96 million for the month through Aug. 20, a 70% increase from the $1.16 billion recorded for the same period of July.

Year to date, sales are up 15% to $28.86 billion from $25 billion last year.

Protection is back

The main trend last week was a return to safety with the use of buffers and broad-based indexes, the data shows.

"Clients want more protection in these manic-depressive markets. They are slightly bullish, but they still need a little cushion," a New York sellsider said.

"Any time the market gets choppy, principal protection is going to be a huge seller, especially when everybody is predicting that things are going to get worse," said Brad Livingston, a distributor at the Income Solutions Group with Capital Guardian LLC.

"If you don't have it, there's not sense in bringing your products out."

Top four

In a sign that downside protection was back in vogue - a reverse from July's trend - the four largest deals all incorporated some form of protection whether in the form of a buffer, a barrier or principal protection nearing 100%.

"We've seen more and more buffers over the past two weeks, no question about it," Livingston said.

Barclays Bank plc priced the top deal with $50.04 million of 0% market-linked step-up notes due Aug. 28, 2015 linked to the S&P 500 index. The deal was sold by Bank of America Merrill Lynch.

If the benchmark finishes above 142.5% of its initial level, investors are long the index with no cap; if it ends positive but below the 142.5% step-up level, investors will get a 42.5% return in the form of a digital payment. The downside is partially protected with a 10% buffer.

Another example of a buffered deal was the second-largest offering, which was brought to market by Goldman Sachs Group, Inc. This issuer priced $45.29 million of 0% leveraged buffered index-linked notes due Sept. 13, 2013 tied to the S&P 500 index with a 1.5 leverage factor on the upside and a 15% buffer for downside protection.

Credit Suisse AG, Nassau Branch priced $40.02 million of 0% index knock-out notes due Feb. 22, 2013 also linked to the S&P 500 index. Sold by JPMorgan, this deal was the No. 3 for the week.

If the final index level is less than the initial index level by more than 23%, the payout at maturity will be par plus the index return. Otherwise, the payout will be par plus the index return, subject to a minimum payout of par.

Finally, JPMorgan Chase & Co. upsized its 0% capped notes due Aug. 18, 2016 linked to the iShares MSCI Emerging Markets index fund to $23.7 million after pricing $23.12 million of the notes on Aug. 15.

The payout at maturity will be par plus the fund return, subject to a minimum payout of 90% of par and a maximum return of 85%.

For the sellsider, the week offered nothing out of the ordinary.

"Investors buy what the private banks are showing them," he said.

"Same usual suspects, always: JPMorgan's private bank, Merrill and Morgan Stanley. Those private banks do the monster deals each month."

Indexes versus stocks

Equity indexes represented the leading asset class with 61% of the total volume at $255 million versus 22% of the market for single stocks at $93 million. The top three deals were tied to the S&P 500 index.

For the month to date, equity indexes surged by nearly five-fold to $1.2 billion from $258 million in July, a month dominated by stock deals.

"It's a flight to quality, no doubt about that," Livingston said, commenting on investors' appetite for broad-based indexes.

The urge to move capital away from riskier structures was dictated by the sharp rise in volatility and a continued market correction.

The CBOE Volatility index, or VIX, which measures implied volatility on S&P 500 options, jumped by 35% to 43 during the week while the S&P 500 ended 6.75% lower.

The flight to quality was evidenced elsewhere in the market with spot gold prices reaching an all-time high above $1,875 an ounce and the 10-year Treasury yield falling below 2%.

"With volatility jumping to the roof I don't know how people are not even more skittish," the sellsider said.

"It's true that anytime volatility is up, it becomes easier to provide a buffer or a barrier.

"But in this environment I would not even buy capital-at-risk notes. I would go for full protection or 90% protection.

"Full principal protection is not easy to price with the cost of options up and the low interest rates giving you only a small margin to buy them.

"But I'm surprised that people go for the simple buffer or barrier. To me, it's crazy."

Better-quality deals

But for some, the ups and downs of the markets create optimal conditions for better deals.

"Volatility creates opportunity," said Livingston.

"I've seen from issuers a number of very short-term deals only open for a couple of days but offering very attractive upside and some principal protection. They were all based on the S&P or some commodity index."

One recent marketing change, he said, was the timing for deal pricing.

"Volatility in the market creates short-term opportunities to price very good deals. Issuers can't hold a deal with confidence for a couple of weeks. But they can show you good short-term buying opportunities," he said.

"Issuers are always trying to price deals with as much protection as possible, as much upside as possible and as short term as possible. That's the ideal.

"Two weeks ago, they couldn't price those deals. But now it's easier as the market has come down and there's more volatility."

Reverse convertibles in limbo

Volatility should be an opportunity for agents pricing reverse convertibles, but this type of structure receded fell 38% last week to $44 million from $71 million the week before.

However, on a month-to-date basis, reverse convertible sales increased 26.5% to $149 million.

Commenting on the weekly decline seen with reverse convertibles, the sellsider said, "It's an end-of-the month product. You'll see a lot next week. In fact, I'm pretty sure there'll be a huge amount of them next week."

But fear can dissuade investors from getting into those products, which are considered among the most risky.

"Advisers are getting spooked," Livingston said about reverse convertibles.

"I'm very cautious myself, and I avoid stocks unless a client requires it.

"And if I pick a stock, it would have to be a very solid company in an industry that is moving up, and you don't see a lot of those right now."

"I have a lot of cash and I do mostly principal-protected and FDIC products right now."

Goldman Sachs was the top agent last week with $120 million sold in 11 deals for 28.8% of the total. It was followed by JPMorgan, which priced $100 million in 17 deals, or 24.1% of the total, and by UBS, which sold 50 deals totaling $64 million, or 15.3% of the total.

For both the month to date and the year to date, JPMorgan is the No. 1 agent.

"Clients want more protection in these manic-depressive markets." - a New York sellsider

"Volatility in the market creates short-term opportunities to price very good deals." - Brad Livingston, a distributor at the Income Solutions Group with Capital Guardian LLC

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