Structured products volume of $456 million lackluster; January so far is well behind December

By Emma Trincal

New York, Jan. 28 – Structured products issuance continued to be weak in the post-holiday shortened week with agents pricing $456 million in 140 deals, a 35% volume decline in the week ended Friday compared to the previous week, according to data compiled by Prospect News.

Volume so far as of Jan. 23 is $2.31 billion, a 42% decline from the same period in December. From a year ago, volume is already down by nearly 5% from $2.43 billion.

While the $117 million decline from January of last year is still not significant, sources paid attention to the gap with December as January is typically one of the best, if not the best month, of any given year.

Worse than December

“Maybe people repositioned themselves last month in anticipation of a January correction,” said a market participant.

“If you expect markets to be more volatile early in the New Year, it would make sense to reposition your portfolio, get some downside protection with structured products in order to hedge your long positions and so you strike deals in December.

“This could explain the relatively high volume seen last month.”

For this market participant, investors may have been “spooked” by the Swiss National Bank’s decision to suspend the peg of its currency with the euro two weeks ago.

The Swiss Bank abandoned its cap, which was set at 1.20 Swiss francs per euro.

“Markets are definitely getting more volatile, and a lot of it has to do with FX volatility,” he said.

“When they abandoned the cap, most equity markets took a hit. It really created a shock. The Swiss market plunged by 15%. The Swiss franc appreciated by 30% within minutes.

“There is a currency war going on worldwide and it brings a lot of volatility. A book could be written about it.

“The U.S. started with QE. Then Abe [Shinzo, Japan’s prime minister,] said ‘why not me?’ And he started his own QE. Now Europe is doing it.”

Treasury trepidation

A sellsider pointed to the Martin Luther King Jr. holiday last week as a slowdown factor.

“Now you have the weather. This week will also be a short week because of the storm. Everything was closed yesterday. It was like another day off,” this sellsider said.

But a deeper cause was to be found in the Treasury market, he explained.

“The 10-year Treasury is playing a funny game with volatility. The moves on the 10-year yield or curve have been pretty volatile.

“That forces people to sit on their hands out of fear of making the wrong move.

“Those swings in the yield curve have created some trepidation.”

Treasuries slid last week in response to the quantitative easing announcement by the European Central Bank, pushing yields higher to 1.69%. But earlier in the month, yields were as low as 1.60%. They were at their highest on the first day of the year at 2.12%.

“In absolute trend, yields are heading to the downside. The market has been rallying up for a few months,” the sellsider said.

“If we keep going into that direction and if volatility persists, it could make people procrastinate because they don’t really know where the market may be headed.”

Selling barriers

The impact of volatility on the structured products market varies, said the market participant.

“Sudden spikes are good for certain products. I know that within hours of the Swiss shock some issuers were able to strike three-month reverse convertibles with a 20% barrier and a 10% coupon, things not seen since 2008. On the other hand, currency wars and central bank policies in general bring tail risk,” he said.

“You don’t know what politicians are thinking and what they’re going to decide.

“Volatility is positive for selling barriers because it increases the skew, and the skew can be quite high on some stocks.

“This in turn helps investors buy insurance against extreme movements.”

Investors bought protection through leveraged notes and some income-oriented products, especially autocallable reverse convertibles.

But the data showed that not everyone was on board to choose defensive structures over aggressive bullish bets.

About 11% of the deals sold last week were leveraged products with buffers or barriers.

Other structures, which often include a trigger or even a buffer, were autocallable reverse convertibles, which made for 29% of the total.

Still, 28% of the market came from pure leverage plays with full downside risk exposure, or $128 million in notional sold in 11 deals, twice the volume of the previous week, according to the data.

“When you look at structured notes you really have two distinct groups,” the sellsider said.

“First, you have people looking for fixed-income substitutes. They want something that gives them yield. Second, you have those seeking growth. The growth investors use leverage hoping that what they get paid at maturity will surpass what they would have received elsewhere. When growth is your objective, you want a short-term play with leverage and the downside protection is not your priority.”

Going for growth

Leverage with no protection came mostly from a single deal: Goldman Sachs Group, Inc.’s $80.03 million of 18-month leveraged notes linked to a basket of five non-equally weighted foreign equity indexes. The offering was No. 1. It featured three-times leverage on the upside up to a 26.25% cap and no downside protection.

The basket consisted of the Euro Stoxx 50 index, the FTSE 100 index, the Topix index, the Swiss Market index and the S&P/ASX 200 index.

Goldman, which sold the top three deals last week, also priced a $29.45 million leveraged index-linked notes deal tied to the S&P 500 index. It also lacked any downside protection, had an 18-month maturity, three times leverage and its cap was at 18.9%.

“There is a negative correlation between equity and fixed income in general. In our little space of structured products, it’s similar,” the sellsider said.

“Growth plays start to pop up when fixed-income deals are less attractive.

“When commodities and equities are not in vogue, you start to see a move toward safety and rate plays.”

The third deal was Goldman Sachs’ $25 million of 0% notes due April 9, 2015 linked to the Topix index, which offered a delta one participation.

Goldman Sachs was the top agent last week, pricing 11 deals totaling $173 million, or 38% of the total. It was followed by JPMorgan and Barclays.

“It’s not surprising to see Goldman on top,” the sellsider said.

“Our market is really a good old boys network.

“You’ll always see the big banks with large wealth management divisions. It’s going to be Bank of America, Goldman, Morgan Stanley and to some degree Citibank and UBS.”

“Markets are definitely getting more volatile, and a lot of it has to do with FX volatility.” – A market participant

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