Issuance doubles to $886 million; market buoyed by volatility, bargain prices, better terms

By Emma Trincal

New York, Aug. 17 - Issuance benefited from a dramatic change in market conditions last week, prompting investors to pour money into structured products as they came across attractively priced deals and bargain-hunting opportunities, sources said.

"The combination of wider credit spreads, lower entry levels due to the sell-off and the volatility move made for a more favorable market environment, pushing up volume," a sellsider said.

Agents sold $886 million in 121 deals excluding exchange-traded notes last week, more than twice the volume sold the week before of $428 million in 94 deals, according to data compiled by Prospect News.

The week followed an even more volatile week marked by Standard & Poor's downgrade of U.S. government debt and heightened concerns over the European debt crisis, noted the sellsider.

The week began with the CBOE Volatility index, or VIX, at its highest level since the spring of 2009. Meanwhile, the S&P 500 index was at its lowest for the year, down 18% from its peak in April.

But the market disruption did not spell bad news for U.S. structured products issuance.

Credit risk compensated

"The trend recently is that we're starting to benefit from the widening of banks' credit spreads," the sellsider said.

"With a higher perceived credit risk, issuers have to offer better terms, either with more leverage or more downside protection."

Since the market turmoil took off in the beginning of the month - the debt ceiling vote was on Aug. 2 - August offers so far a brighter picture than July in terms of volume, data shows.

Agents priced $1.31 billion in August as of Friday, more than double the $609 million volume recorded during the first two weeks of July.

Volume picked up also on a year-to-date basis. Agents have sold $28.2 billion in 2011 so far, up nearly 15% versus the $24.5 billion sold in the first seven and half months of last year.

A lot of the advance seen this year can be attributed to recent market developments, sources said.

"After the S&P downgrade of the U.S. debt, credit spreads shot up," the sellsider said.

"If there's a lot of sovereign risk, any issuer will be impacted by that.

"It's getting harder for banks to raise debt because of the market. So they have to pay more, and as a result, you're finding structured notes with much better terms."

Offerings have also become bigger in size.

Last week, for instance, agents priced four deals over $50 million each versus only one the week before.

In the first half of August, five deals in excess of $50 million were sold, but none were sold during the same period in July.

With the Dow Jones Industrial Average dropping 865 points in the first half of August, the market is ripe for bargain hunters, the sellsider said.

"This is another plus for investors," he said.

"You have lower market levels, better entry points. This gives you better terms, such as higher participation rates for instance."

Buffer fashion

While investors early on this summer showed a strong appetite for leverage without buffers, the opposite is now true, data shows.

"Before the market dislocation with the credit rating, a lot of investors were bullish and happy to take a lot of leverage. But now there are more sideways or bearish views, and you'll see a reverse of the pure leverage trend," the sellsider said.

Leveraged notes with partial downside protection last week jumped in volume to $183 million from $10 million the week before. They accounted for 21% of total volume versus 2.5% in the prior week.

For the month to date, this type of structure has doubled in volume to $193 million.

"People on the institutional side are trying to hedge themselves," a market participant said about the renewed interest in buffers and barriers.

For the sellsider, buffering is probably one of the structuring terms that may benefit the most from wider credit spreads.

"Higher credit spreads help mostly capital-protected products because you can greatly improve the buffers," he said.

"It's even true for fully protected notes. You still have the low interest rates, which are a problem. But low interest rates have been a problem all along, and they can't go much lower while credit spreads can go quite high. So in many cases, you've seen the benefit of wider credit spreads offset the negative impact of low rates."

Another factor that helped those protected structures, he said, has been the decline in volatility. The VIX fell 25% to 36 from 48 last week.

"The volatility came down, which is good for those products," he said.

"Anything with uncapped participation or capital-protected notes will benefit from it."

Volatility still high

While volatility declined last week, it remained well above its prior peak of 30 in March.

The volatility spike is good for some products, the sellsider said, in particular knock-out structures, which were the most popular type of product last week.

Agents sold 17 knock-out deals totaling $346 million, or 40% of the total volume, in this structure category.

"Reverse convertibles, autocallables and knock-out are all short volatility and respond well to higher volatility levels," the sellsider said.

"Anything that caps your return, any short-term note that may not give you a return or may force you to exit if the market moves a lot, these benefit from volatility spikes."

An example was last week's top deal, HSBC USA Inc.'s $82.59 million of knock-out buffer notes due Feb. 19, 2013 linked to the S&P 500 index. JPMorgan was the agent.

The knock-out barrier is 20% below the initial price and observable any day during the life of the notes.

In some cases, the issuer can even offer a contingent minimum return, benefiting from the higher premium.

Morgan Stanley for instance priced $61 million of 0% buffered jump securities due Feb. 17, 2015 linked to the S&P 500 index.

The knock-out buffer is 10%, and the minimum contingent return is 35%.

Fear and greed

Reverse convertibles increased by 48% to $47 million. For the month, the volume in this product type is only $79 million, but it's 24% higher than July, a month that was not good for those products, according to data compiled by Prospect News.

"You have fear and greed in this market. Yes, reverse convertibles are more attractive right now, but the market is down. So you have more fear than greed I guess," the market participant said.

"Volatility recently was too high. There has been a dramatic panic in the market. The risk of reverse convertibles is a bit much for the market," the sellsider said.

"The success of a product or structure always depends on a balancing act. The product needs to look good, but the investor needs to be comfortable with the risk too," he said.

Autocallable deals increased nearly three-fold last week to $67 million from $26 million the week before.

This product type also did better for the month to date with $92 million sold versus $27 million in the first half of July.

"Autocallables are perceived as less risky than reverse convertibles. They have a fixed-income kind of feel to them, they get called at certain levels. They have a bit of a protection," the sellsider said, explaining their relatively strong issuance pace.

The top autocallable deal for the week and the third largest offering overall was brought to market by Royal Bank of Canada, which priced $59.11 million of 0% Strategic Accelerated Redemption Securities due Aug. 20, 2012 linked to the S&P 500 index.

The call premium is 12.2% and the buffer 10%.

Bank of America Merrill Lynch was the agent.

Equity via S&P 500

Equity as an asset class is back with $718 million sold last week, or 81% of the total, versus $335 million the week before.

For the month, equity-linked notes tripled in volume to $1 billion from $346 million.

"A lot of money has been sitting on the sidelines. A lot has gone to alternative investments, commodities and gold," the sellsider said.

"With wider credit spreads, better entry points, renewed volatility and corporations that have solid balance sheets, investors are looking at equity products again."

However, investors in equity were essentially drawn to equity indexes rather than single stocks.

Equity index products saw their market share rise to 70% of total volume from 44% the week before.

In volume, investors bought $612 million of equity index-linked notes, more than three times the volume bought during the prior week at $190 million.

Stock deals in the meantime decreased by 25% last week to $99 million from $132 million.

Among indexes, the S&P 500 was the underlying of choice; the top seven deals issued last week were all based on this benchmark.

JPMorgan was the top agent last week with $204 million sold in 24 deals, or 23% of the issuance volume.

It was followed by Goldman Sachs with $192 million in 13 deals and by Morgan Stanley, which priced six deals totaling $133 million.

"People on the institutional side are trying to hedge themselves." - A market participant

"Autocallables are perceived as less risky than reverse convertibles. They have a fixed-income kind of feel to them. ..." - A sellsider

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