Issuance falls 12% to $403 million due to IRA contributions, structured products conference

By Emma Trincal

New York, April 20 - Tax season and an industry conference put the brakes on structured products issuance last week, and issuers continued to strive for flexible structures given daily volatility swings, sources said.

Agents sold $403 million in 114 deals in the week ended Friday, down 12% from the week before, which saw the pricing of $460 million in 65 deals, according to preliminary data compiled by Prospect News.

The weak volume translated into more tiny deals: 68% of the offerings last week priced at $1 million or less. Simultaneously, the number of deals over $10 million dropped to nine last week from 25 the week before.

Sales have declined so far compared to last month, possibly due to the lesser amount of exchange-traded notes issuance in April as of Friday.

Volume this month is down nearly 7% from last month at $943 million excluding ETNs. When all deals are included, sales dropped by 89% to $1 billion from $9.7 billion.

"It's been slow. It's been weak across all asset classes," a market participant said.

Miami, taxes, earnings

One explanation, he said, was a structured products conference sponsored by mtn-i, which took place during the end of last week in Florida.

"You had 150 delegates who were out last week networking, talking about structured products. The whole industry was in Miami," he said.

"It's also earning season for some issuers," the market participant said. "They can't price some plain vanilla deals because of the quiet period."

People making last-minute 2010 contributions to their Individual Retirement Accounts was also an important factor, he said, especially for certificate of deposit investors.

"It's the tax season. It's CD rollover time. You had a big CD roll," he said.

Lisa Smith, who is in charge of structuring at Bankers Financial Services LLC, agreed that CDs were on the forefront last week.

"Note issuance may be weak, but in the CD market, it's the opposite," she said. "March and April have been heavier because investors made their 2010 IRA contributions."

On a year-to-date basis, agents are still ahead this year with $14.2 billion deals excluding ETNs versus $13.15 billion last year. March was the best month of the year with $12.85 billion issued, or more than half of the first quarter's volume.

But a sellsider said that recent events in Japan and the Middle East do not contribute to optimism in the markets.

"This year is a disaster," he said. "People are terrified by what's going on in the world. Even though U.S. companies have posted good earnings, people remain skittish. They don't have a view on macroeconomic events."

Volatile VIX

Some market participants are puzzled by the tendency of volatility as measured by the CBOE Volatility index, or VIX, to decline despite the increased global uncertainty.

One source pointed to last week's VIX, which closed down 7% while showing daily spikes such as a 3% rise on Tuesday.

"Volatility swings are very frustrating from a pricing perspective," said Smith. "You can't depend on it. You have to build on large margins with caps of a 3% to 4% range.

"You offer the product, you create the disclosure. But you don't strike the option until the pricing date. There's still a lot of volatility, and we're seeing a lot of swings in pricing."

This "volatility of volatility," as sources called it, has an impact on how deals get structured and priced. Low interest rates and swings in volatility create an environment in which options pricing has become more challenging, structurers said. As a result, issuers are striving for maximum flexibility.

Knock-outs

One structure that is gaining popularity is capped knock-out notes.

Those products amounted to 9% of the total last week, which was more than reverse convertibles' 8% share. Leveraged notes accounted for 15%, still topping the list.

Knock-outs have a downside barrier and a cap on the upside. They often offer a contingent minimum return if the knock-out barrier is not breached.

An example last week was Barclays Bank plc's $12.08 million of 0% capped market plus notes due April 26, 2012 linked to the price of palladium. If the final price of palladium is less than 80% of the initial price, the payout at maturity will be par plus the palladium return. Otherwise, the payout will be par plus the palladium return, subject to a minimum return of 8.15% and a maximum return of 20%.

Some variations of the structure include barriers that can be breached at any time during the life of the notes.

The sellsider said that those structures differ from reverse convertibles in that they still enable investors to participate in the upside anywhere from the coupon to the cap. In this regard, they are growth products, he said.

"Issuers are replacing leverage with contingent coupons. People like coupons. Volatility is so low, it doesn't pay much to do reverse convertibles," the sellsider said.

But to find better pricing for the embedded options, issuers often need to structure those knock-out deals around volatile underlyings, said a structured products analyst. The more volatile the underlying, the greater the odds of breaching the barrier, which makes the option cheaper, just like a reverse convertible, he explained.

"A lot of those knock-outs are usually commodities based. It might be cheaper to price if the underlying is volatile."

He said that knock-outs are built on digital options, which offer a coupon paid out once the underlying is above the strike price.

"Those digital coupon options are cheaper. As long as it doesn't go through the barrier level, you get paid, regardless of how much you are above that level," he said.

But some sellsiders said they don't like the risk associated with those products.

"We structured a few of those knock-outs a couple of years ago," said Smith. "But they ended up breaching the barrier and not paying out, so we don't do them anymore."

More stocks

Stock-linked deals gained momentum last week. They grew 84% to $144 million compared to the prior week.

At the same time, appetite for index equity-linked notes retreated. Agents sold only $38 million of those deals, compared with $123 million the week before.

The sellsider said that most of the stock-linked notes sold last week were probably rollover sales.

"Most stock deals have short maturities. You don't want to take a long-term bet on a stock. People want short-term deals right now.

"And you probably have some rollovers. Those deals were probably issued in September. They matured in March and rolled over in April."

Top offerings

The top deal of the week was a stock-linked note priced by Merrill Lynch for AB Svensk Exportkredit. It was a $69.81 million offering of 9.25% STEP Income Securities due April 27, 2012 tied to Ford Motor Co.

Morgan Stanley priced $49.71 million of fixed-to-floating notes due April 25, 2023 linked to the Consumer Price Index in the interest rates asset class, which amounted to nearly 14% of total issuance. The deal was the second largest in size. The notes offered a fixed coupon of 6.5% for the first two years. After that, the coupon is tied to changes in the index plus 200 basis points.

HSBC USA Inc. priced the third deal and the largest equity index product with $37 million of 0% return enhanced notes due Oct. 19, 2011 linked to the dollar-adjusted return of the Hang Seng China Enterprises index. JPMorgan was the agent.

The fourth deal was a commodities offering. Merrill Lynch priced $23.69 million of 0% Strategic Accelerated Redemption Securities due Dec. 2, 2011 linked to the front-month corn futures contract for Eksportfinans ASA.

JPMorgan led with 26% of the total volume, pricing 14 deals totaling $104 million.

It was followed by Merrill Lynch, which sold $97 million in only three deals, gaining 24% of the market.

Morgan Stanley took the third slot with $51 million sold in two deals for nearly 13% of the volume.

"This year is a disaster. People are terrified by what's going on in the world." - A sellsider

"Volatility swings are very frustrating from a pricing perspective." - Lisa Smith, head of structuring at Bankers Financial Services LLC

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