Sales fell by half last week amid equity rally, summer vacations, but August still looks good

By Emma Trincal

New York, Aug. 29 - With investors bullish or on vacation, structured products issuance was uninspiring last week despite a nice bump the week before, according to data compiled by Prospect News.

And while August has outpaced July's issuance size by one third, the negative gap for this year compared to last continued to increase.

Leveraged notes with partial downside protection as well as knock-out structures led the pack in notional size.

Reverse convertibles are staging a quiet comeback with multiple little deals that add up. Last week, for instance, UBS topped the league tables with a plethora of tiny deals in that structure category.

Equities dwarfed every other asset class with 91% of the market as investors continued to be lured by well-known benchmarks.

Agents sold $255 million in the week ended Friday, roughly half of the $524 million that priced the week before.

The number of deals - 101 last week versus 107 the previous week - remained stable, which showed a reduction in average size.

The largest issue last week was only in the $25 million ballpark, and the number of deals over $10 million fell to four from 18 the week before.

The monthly data showed a brighter picture: $1.31 billion of notes priced from Aug. 1 to Aug. 25, compared with $980 million during the same time in July, a 34% increase, which in part was the result of last week's robust sales pace.

But August this year compared to a year ago saw sales volume drop by 53% from $2.77 billion.

"I'm surprised that there's not more volume given that there is no yield to be had in the fixed-income space. The equity market is relatively high; it keeps on getting higher. People are probably a little gun shy," a sellsider said.

For the year to date, agents have sold $22.93 billion, a 23% decrease from last year's $29.72 billion

Where's the yield?

"I wouldn't have expected such a big decline from last year," the sellsider added.

"If you compare last year's 10-year Treasuries of 2.15% with 1.65% now, you'd think we'd see much more demand for structured notes," he said.

The Prospect News figures do not include exchange-traded notes, certificates of deposit or non-registered notes. Plain-vanilla rates-linked notes such as fixed-to-floaters, capped floaters and step-ups are also not taken into account.

"I know that rates products are a big piece of the market, but still," the sellsider said.

"They don't give you that much of a [yield] pickup. That's why I'm surprised that not more people have migrated into equities-linked notes," he said.

For this sellsider, the major explanation for the slowdown in the registered notes space is probably the market itself. When news is too good in the overall equity market, issuers and brokers have a harder time selling structured products, which are seen as a tool to reduce risk by many.

Despite the euro zone crisis, the pending elections and the fiscal cliff in the United States as well as the threat of an economic slowdown in several countries, including China, investors have remained bullish, pushing the S&P 500 index up 10.5% in the last three months.

Sources suggest that investors may just be as happy investing in equities while the rally is still there.

Hidden market

For a structurer, the data may not reflect the hidden part of the iceberg. Therefore, sales may not be as lackluster as they seem.

"For the most part, these figures reflect the business of U.S. banks, and those are the ones the most affected by the downgrades. They have struggled the most," he said.

Moody's downgraded 15 major global banks in the United States, Canada and Europe at the end of June. Several U.S. banks were downgraded two notches. For example, Bank of America was downgraded to Baa2 from Baa1 and Citigroup was downgraded to Baa2 from A3. In contrast, Societe Generale was downgraded only one notch to A2 from A1. BNP, cut two notches, saw its rating changed to A2 from Aa3.

"As far as European banks are concerned, the volume is good, but you don't see it because their retail business is private. The U.S. market is down, people have told me that, and you see some of the European banks, French banks in particular, capturing some of the U.S. banks' business," he said.

This structurer also noted that the picture could not be complete when excluding both CDs and fixed-income plain-vanilla deals.

"Without the CDs and the longer-dated fixed-income notes, you probably see only 10% of the market," he said.

"Longer-dated fixed-income [notes] are the top-selling products, and CDs clearly are huge compared to notes," he said.

Investors continued to bid on products reflecting their views, which tend to reflect range-bound expectations or cautious bullishness, sources said.

Favored structures

Among the most popular structures are knock-out notes such as digital knock-outs or capped knock-outs with a minimum contingent return.

They offer enhanced return whenever the underlying closes above a downside barrier and below a digital coupon or cap.

"Most people think we're at the top or they see the market trading very range bound. You want to outperform if the market doesn't do a lot. I think that's why those knock-out products can make sense," the sellsider said.

Leveraged notes with a buffer or barrier continued to be in demand, making in general for 25% to 30% of the volume.

A more recent trend is the re-emergence of reverse convertibles, callable reverse convertibles and autocallables, which some sources said is somewhat surprising given the low volatility levels.

But this business is spurred when investors are confident, a source said.

In addition, some firms specialize in selling those structures in very small increments but in a multitude of offerings.

Last week, agents sold $87 million of reverse convertibles of all types, which represented nearly 35% of the market. However, the total of deals was 65, which points to a small average size of less than $1.5 million.

UBS exemplifies this pattern of selling small. The firm topped the table last week with $83 million priced in 60 deals, taking on a third of the volume.

All but two of those deals were reverse exchangeable or autocallables. Their sizes ranged from $99,000 to $8.1 million.

"UBS has a very robust exchange-reverse convertible pricing tool. For them, it's very easy and cost-efficient to do any size, which helps them. They can do bespoke, one-off much easier and quicker than most other firms," the sellsider said.

"Certain firms don't have the technology in place, while some others are working on it. But in general, firms prefer to stick to a minimum size, something like $250,000 or $500,000.

"And it's easy to understand why: each offering involves a minimum cost. It takes time to put the deal together, generate the docs, it takes work and money, and there is the legal time associated with it. So I think that UBS is rather unique that way."

Top deals

The largest deal last week was a knock-out. JPMorgan Chase & Co. priced $25.57 million of 0% capped index knock-out notes due Sept. 11, 2013 linked to the Euro Stoxx 50 index.

The knock-out level is 70% of the initial level. Without a knock-out, investors will receive a digital payment of 10%. If a knock-out event occurs, investors are long the index, capped at 10% on the upside and subject to full losses.

JPMorgan sold the second-largest deal on the behalf of HSBC USA Inc., which issued $17.86 million of 0% buffered return enhanced notes due Sept. 11, 2013 linked to the Euro Stoxx 50 index, the Topix index and the FTSE 100 index.

The payout at maturity is based on the basket return. A 18.9% cap and 10% buffer are applied to each basket component.

More unusual was Royal Bank of Canada's $11.59 million of 0% bear Strategic Accelerated Redemption Securities due Feb. 25, 2013 linked to the Russell 2000 index. Sources said that bear notes are rare because they are difficult to sell.

The notes were sold by Bank of America and give investors an 8.85% return if the final index return is negative but an unlimited loss potential if the index finishes higher than its initial level.

After UBS, JPMorgan was the No. 2 agent last week with $48 million sold in eight deals, or 19% of the total. HSBC was third with $34 million in 11 deals, or 13.5% of the market.

"If you compare last year's 10-year Treasuries of 2.15% with 1.65% now, you'd think we'd see much more demand for structured notes." - A sellsider

"As far as European banks are concerned, the volume is good, but you don't see it because their retail business is private." - A structurer

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