March debuts in slower mode than January, February with $233 million sold in first week

By Emma Trincal

New York, March 12 - Action slowed down in the first week of March compared to the first weeks of January and February amid indications that investors may be becoming more skittish, according to sources commenting on data compiled by Prospect News.

Volume in the week ended Friday was $223 million in 85 deals, according to the data. In comparison, during the first week of January, agents sold $581 million. February fared even better with $634 million priced in the first week.

How strong a month begins does not necessarily determine the pace for the monthly volume, sources said.

For instance, January as a whole ended up being a better month than February with $4.12 billion of volume versus $3.74 billion in February. In all cases, the key factor will be the final week of the month.

Too soon to tell

"January and February were great months, particularly for my company," a market participant said.

"The reason why those first two months were so great is because our retail clients were bullish on the market and willing to take money they had on the sideline and go to structured notes that give them upside potential features with a certain protection on the downside. They wanted the equity exposure but had to be comfortable with it."

So far the year looks stronger than last year with sales amounting to $8.07 billion as of March 7, a 10.5% increase from $7.30 billion during the same period of last year, according to the data.

Last week's data may not give any insight as to what March activity will be like, sources said.

"Our market has a monthly cycle. With everybody settling on Friday last week, people are more focused on getting their monthly deals out as opposed to pricing their weekly deals," a sellsider said.

"For us, January was well below February. But at this point, nothing really indicates whether March will be particularly strong or weak. It's too soon to tell."

Only one offering exceeded the $20 million size last week, compared with 21 the week before, a skewed comparison, however, given that it was the closing week of February with $1.88 billion issued.

Smart beta

JPMorgan Chase & Co. priced the largest offering of the week on Monday with an additional $21.64 million of 0% return notes due Nov. 27, 2018 linked to the J.P. Morgan Enhanced Beta Select Backwardation Alternative Benchmark Total Return index. The total issue size is now $305.03 million.

The index is a notional dynamic index that tracks the return of seven weighted synthetic excess return subindexes that reference futures contracts on 22 specified commodities plus the return on three-month Treasury bills. The index algorithm is designed to allocate exposure to the futures contracts with the highest degree of backwardation. Backwardation is a downward sloping forward curve that generates a positive yield for the rolling of the futures contracts, which is desirable for the investor.

"You'll see more and more of those smart beta deals," the sellsider said.

"People are getting more comfortable with those rule-based indices. Some of the algorithms can be relatively complicated. But if you can explain the concept of the index and demonstrate how it can generate returns, whether you get those returns with volatility bets or value plays or equally weighted strategies, as long as the theory behind it can be explained pretty easily, you'll see more and more demand for these products."

Seadrill, Facebook, Mylan

The next three deals were all linked to stocks. Single stocks as an underlying asset class has surged so far this year, rising 55% to $2.26 billion. As a percentage of the market, single stocks now account for 28% of total volume, versus 53% for equity indexes. Baskets of stocks have also increased significantly, up 46%, but their 3.5% market share remains small.

"Single-stock deals tend to be quick deals," the sellsider said.

"They are getting done by bigger firms with large distribution networks where people look at deals on a daily basis and where you can easily put together a $5, $10 or $20 million offering in a short period of time.

"For firms that don't have hundreds of high-end brokers, it's harder to put out a deal and convince enough people to do it. We do a few but not tons of it. It tends to go in cycles, and we do a fair amount of them as reverse inquiries."

JPMorgan priced the No. 2 deal with its $18.31 million of contingent income autocallable securities due March 9, 2017 linked to the common stock of Seadrill Ltd.

If Seadrill stock closes at or above the downside threshold level - 75% of the initial share price - on a quarterly determination date, investors will receive a 4% contingent payment for that quarter.

The notes will be automatically called if the closing share price is greater than or equal to the initial share price on any quarterly determination date.

At maturity, the payout is par plus the contingent payment if the stock price finishes above the downside threshold level.

Barclays Bank plc sold another contingent income autocallable, $17.84 million of securities due March 12, 2015 linked to Facebook, Inc. shares. The downside threshold is 65%, and the quarterly contingent payment is 3.1%.

Wells Fargo & Co.'s $13.67 million of 0.125% optionally exchangeable notes due March 13, 2019 exchangeable for a basket of common stocks was the fourth deal of the week. The basket components are Mylan Inc. with a 75% weight and American Airlines Group Inc. with a 25% weight.

Interest is payable semiannually. Each security is exchangeable at any time for a number of shares of each basket stock equal to its exchange ratio. The issuer can settle exchanges in shares or cash. The notes are callable after two years.

Back to yield

"Compared to January and February, where the focus was on growth, we're seeing maybe a shift back to yield," the market participant said.

"That could explain the continued growth of single-stock deals, which is often the underlying used in autocallables."

Autocallable reverse convertibles continue to be one of the fastest-growing structures this year, up 33% from last year and making for 20.5% of the total, according to the data. Delta-one, tracker-like structures have grown at an even faster pace, up nearly 160%. But they represent only 7.5% of the total.

While any type of leverage deal showed strong volume growth last year, the same cannot be said of 2014. Leveraged notes with some form of partial downside protection (buffer or barrier) are on the rise while leveraged plays with full downside exposure are on the decline.

"If you see more leveraged buffered notes, it's simply because people realize that we are kind of at a peak. It makes sense for investors to seek protection," the market participant said.

Protection, please

According to the data, leverage with no downside protection is down 35% and accounts for 14.31% of the total. Meanwhile, leverage with partial protection, which represents 17.16% of the year-to-date volume, is up by nearly 16%.

"You see less leveraged deals without downside protection because of the length of this bull market," the market participant noted.

"The equity market had a huge run-up in the recent years. Our clients are optimistic, but they're not stupid. They know that potentially there can be a pullback. They want to continue to have equity exposure but with some protection.

"For a lot of people, it feels like we are at a peak. A lot of variables may slow down the course of the current rally or even facilitate a pullback. You have the Fed tapering; you have geopolitical events happening in the world, in particular in Ukraine.

"Given that, the risk/reward profile as an incentive of using the leverage without protection is not that attractive anymore as it was last year.

"With a market at an all-time high and the risk of a downturn, is it the smart thing to do to try and maximize the upside without getting protection? People are a little bit more skittish, and they are not willing to take on that bet."

It does not mean that investors are giving up their equity exposure for other asset classes. Commodities, for instance, which have been rallying, are still not perceived as attractive in the structured notes market.

Volume in commodities-linked notes issuance is down 35% this year, falling to $276 million from $423 million last year.

"We're not noticing a pickup in commodities deals right now. Things have been broad equity markets-focused," the sellsider said.

JPMorgan was last week's top agent pricing 12 deals totaling $78 million, or 35.22% of the total. It was followed by Barclays and UBS.

"At this point, nothing really indicates whether March will be particularly strong or weak." - A sellsider

"If you see more leveraged buffered notes, it's simply because people realize that we are kind of at a peak." - A market participant

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