Year kicks off with a big commodities deal; volume hits $130 million in first two days of 2014

By Emma Trincal

New York, Jan. 8 - The year 2014 began with a $60.9 million commodity deal linked to palladium, the largest issue of the week and a surprise for some given the drop in appetite for this asset class.

Meanwhile, sales reached $229 million in the week ended Friday, with $130 million issued on just the first two days of the year, Thursday and Friday, making the first week of the year already better than a year ago.

On Jan. 2 and Jan. 3 of last year, agents sold $57 million, according to data compiled by Prospect News.

"People are coming out of vacation. It's the deep freeze. It's really too soon to draw any conclusion from the first week of the year," a structured products analyst said.

But sources said the outlook is positive for 2014 as many are predicting that last year's rally will slow down or even revert, making the demand for structured products all the more pressing for investors seeking downside protection.

A distributor said, "We're very optimistic for this new year. We've already seen a bit of a pickup. So much of what we do depends on what the market is doing. We may not have the same bull run as we had last year, but with volatility picking up and pricing becoming more attractive, demand for structured notes may increase as investors may be looking for more defensive strategies."

The analyst said, "Structured products have always this possibility to deliver different means of payout and risk profile. It's the flexibility of structured investment products that can benefit investors in this environment whether in terms of yield enhancement, portfolio diversification or different risk return profile."

Palladium rush

Barclays Bank plc's $60.9 million issue of 0% buffered return enhanced notes due Jan. 20, 2015 linked to palladium was the top deal of the week and the year so far, according to the data.

Barclays was the underwriter, and J.P. Morgan Securities LLC was the dealer.

The upside is leveraged at a rate of 1.4 times with a 14% cap. There is a 10% buffer on the downside with a 1.111 downside leverage factor beyond the 10% buffer.

Commodity-based issuance declined by nearly a third to $1.99 billion last year from $2.94 billion in 2012, according to the data. From 8.36% of the overall volume in 2012, this asset class fell to 5.22% last year. The number of offerings decreased 40% to 205 from 341.

Possible turnaround

The loss of investor appetite for commodity deals reflected a disappointing performance, sources said. The S&P GSCI declined 1.2% last year. In December, however, the index posted a 1.9% gain, and some commodities performed well during the year, according to S&P Dow Jones Indices.

Natural gas, for instance, recovered in the last two months of the year, posting the best performance in the S&P GSCI index with a 9.2% return. Gold on the other hand incurred a sharp correction, down 28.65%.

"We're seeing increasing opportunities in commodities in specific asset classes or specific parts of the market, which this deal is a good representation of in terms of picking a specific view of that segment of the market," a market participant said, commenting on the Barclays palladium offering.

"Gold was not a strong performer last year, but the precious metals segment has its own intricacies, and some parts of it offer appealing opportunities."

Asked whether 2014 would be a year of recovery for commodities, he said, "Commodities still represent a small allocation in most investors' portfolio. At the same time, some sectors offer very attractive prospects. Last year for instance, natural gas was the top performing sector.

"Will there be a turnaround this year with more volume in commodities-based issuance? It's too soon to tell. But the fact that demand for diversification may increase combined with the very diverse nature of the commodities asset class should be encouraging.

"There will be winners and losers in terms of performance, and selecting the right commodity or sector will be increasingly relevant to yield returns in this asset class. But will it be the year of commodities after last year's fall? No one can tell."

The future of commodity-based issuance this year "depends on whom you ask," the distributor said.

"All of this Barclays deal went to JPMorgan's internal distribution group, the private wealth group, which is pretty much the smart money," he said.

"Smart money will be buying commodities-based structures with the direction of the global economy.

"I don't think the same can be said about the retail side though. Retail investors will continue to shy away from the asset class. You are not going to see a lot of demand for commodities-based structures in this part of the distribution space," he said, adding that it is hard to predict whether there will be a rebound in commodities issuance this year.

"So much depends on where the demand is coming from," he said.

Diversification factor

Commodities may be sought after again for the benefit they are believed to provide: diversification from equity, sources said.

"Structured notes tied to commodities collapsed in volume last year, which was justified by the poor performance of most commodities asset classes," the analyst said.

"But as people start to look for diversification again, the pendulum may move back to commodities. Equity-based structures had a good run last year and posted huge gains. You're not necessarily going to see a repeat of that this year, and as a result, people may need to allocate to different asset classes. Commodities might be one part of the equation.

"Commodities are a good diversifier, although it's not necessarily always the case. In the 2008-09 bear market, commodities were highly correlated to all asset classes. But in general, yes, they provide this diversification benefit to the investor."

Autocallables linked to stocks

Last week showed a balanced mix between single-stock issuance (22% of the volume) and equity indexes (34%), with indexes usually accounting for a higher proportion.

The No. 2 deal was linked to a single stock. It was an autocallable reverse convertible sold by Morgan Stanley Wealth Management and brought to market by Royal Bank of Canada: $17.69 million of contingent income autocallable securities due Jan. 6, 2017 linked to the common units of Blackstone Group LP.

If Blackstone shares close at or above the downside threshold level, 70% of the initial price, on a quarterly determination date, the notes will pay a contingent payment of 2.9% for that quarter.

If the closing price is greater than or equal to the initial price on any of the first 11 quarterly determination dates, the notes will be automatically redeemed at par of $10 plus the contingent payment.

If the notes are not called and the final share price is greater than or equal to the downside threshold level, the payout at maturity will be par plus the contingent payment. Otherwise, the payout will be a number of Blackstone shares equal to $10 divided by the initial price or, at the issuer's option, a cash amount equal to the value of those shares.

Morgan Stanley sold a similar deal, which was the fifth largest one for the week. It was Morgan Stanley's $14.07 million of contingent income autocallable securities due Jan. 9, 2017 linked to the shares of JPMorgan Chase & Co. The contingent quarterly payment has an annual rate of 9%. The coupon barrier and final barrier are 80% of the initial price. One particularity of this deal is its step-up redemption threshold, which increases from 105% of the initial price to 110% and finally 115%.

Absolute value

The third- and fourth-largest deals both had dual directional structures.

One was Citigroup Inc.'s $17.59 million of 0% dual directional trigger Performance Leveraged Upside Securities due July 5, 2019 linked to the Euro Stoxx 50 index.

If the final index level is greater than or equal to the initial index level, the payout at maturity will be par of $10 plus 130% of the index return.

If the final index level is less than the initial index level but greater than or equal to the trigger level, the payout will be par plus the absolute value of the index return. The trigger level is 65% of the initial index level.

If the final index level is less than the trigger level, investors will be fully exposed to the decline from the initial index level.

Citigroup Global Markets Inc. was the agent.

The second absolute return product, another Morgan Stanley deal, was $14.93 million of 0% dual directional trigger PLUS due Dec. 31, 2019 linked to the S&P 500 index. The participation rate is 115%, and the upside is also uncapped. The trigger level is 65% as well with the same conditions applying

Barclays was the top agent last week with $71 million, or 31.17% of the total. It was followed by Morgan Stanley and JPMorgan.

"We're very optimistic for this new year." - A distributor

"As people start to look for diversification again, the pendulum may move back to commodities." - A structured products analyst

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