Despite rally, volume is dropping; investors' focus is on income products, not growth

By Emma Trincal

New York, Feb. 15 - Week after week, the downward trend for U.S. structured products issuance seems to be confirmed with sales down not only week to week but also on a monthly and yearly basis, according to data compiled by Prospect News.

While the U.S. stock market has reached new highs last month, structured notes investors appeared to be content with income products that limit their upside potential while reducing their downside risk, sources said.

"The overall trend so far is a decline, and that's disappointing," a structurer said.

"I'm cautiously optimistic but it's not a very encouraging start."

"It's a little bit troubling because the market has gone up. When the market rallies, you tend to see more structured products since people become more bullish and more confident," he said.

Disappointing volume

Excluding exchange-traded notes, agents last week sold $183 million versus $426 million during the prior week, a 57% decline.

While the prior week included some of the last days of January, making the pace of issuance perhaps stronger then compared to last week, figures for the month to date - from Feb. 1 to Feb. 11 versus the same period in January - confirm the downtrend.

Agents sold $522 million for the month in 161 deals versus $901 million in 118 deals in January, which represents a 42% drop in volume, according to the data.

Year over year - year to date compared to the same period in 2011- issuance volume decreased by 47% to $3.42 billion from $6.47 billion while the number of offerings increased to 806 from 691.

Deals are getting smaller in average, and the number of big deals is shrinking.

Between Jan. 1 and Feb. 11 of last year, agents priced 32 deals in excess of $50 million. Only seven deals of such size have been brought to market so far this year.

The number of deals in the $20 million or more range decreased by almost three-fold to 32 this year from 90 last year, according to the data.

"I can't attribute the drop in volume to anything since it's only been a month," the structurer said.

"We're not in dire straits and there is no need to be completely alarmed at this point. But it's not very satisfying."

This structurer however pointed to recent regulatory events, in particular Finra notice 12 03 entitled "supervision of complex products," saying that the recommendations made by the regulator were unclear and could contribute to some degree to put some of the activity on hold.

"We can't really blame volume drop on Finra. But it doesn't help," he said. "It's already a tough market. And people are confused."

Surprise rally

Some sources struggle to reconcile the weaker issuance pace in structured products sales with the equity rally. The S&P 500 so far this year is up by 5.5%. One explanation, according to a structured products distributor, is that despite higher stock prices, Greece continues to cast a shadow over investors' confidence.

"People are still trying to figure out what's going to happen in the euro zone. Issuance has been quieter as a result of that," he said.

"The rally has been somewhat of a surprise and there are a lot of different things, in particular geopolitical factors like Iran or oil that could snap those gains back.

"I hope it doesn't happen. But people are muted in their enthusiasm for the market," he said.

Last week showed how the discussions relating to the Greek bailout impacted the market. The Dow Jones industrial average posted its largest drop for the year, falling 0.7% just on Friday after the release of negative news from Greece.

The uncertainty around a potential default on the Greek sovereign debt has revived fears around credit risk in general, this distributor noted.

"The appetite for taking on credit risk is muted right now. But once we get a little bit of direction about Greece, we'll see things picking up," he said.

Equity down

Equity-linked notes have seen their volume decline for the month and the year, dropping by 48% and 40%, respectively. However, stocks have fared better than equity indexes, according to the data.

While notes tied to equity indexes fell by 54.5% this month to $227 million from $499 million, single-stock-linked products slightly rose by 3.17% to $139 million from $135 million.

Exchange-traded funds grew more convincingly, doubling up to $45 million from $22 million.

Reverse convertible notes issuance grew by 17% this month to $40 million and accounting for nearly 8% of the total from 3.85% last month, showing encouraging signs of recovery. However sales in this category of product remain depressed, down 68% from last year.

Income deals

Investors last week were attracted mostly to income products, which were represented in the two largest offerings.

The first one was HSBC USA Inc.'s $35.12 million of 9.5% coupon-bearing notes due Feb. 25, 2013 linked to the common stock of Chesapeake Energy Corp.

The notes offered a 10.26% buffer observable at maturity.

Bank of America Merrill Lynch was the agent.

HSBC also brought to market the No. 2 deal with $15.45 million 8% STEP Income notes tied to Citigroup Inc. via Merrill Lynch.

Investors were paid a 2.27% step payment if the final stock price was greater than or equal to the 108% step level. They received par if the price closed at maturity between 90% of the initial price and the step level. Below the 90% threshold, investors would lose from the 90% strike price.

"The trend is toward investors willing to give up the unlimited upside for some protection and it reflects the uncertainty of the market," the structurer said.

"In general people are mildly optimistic. They're still buying bullish structures but with a cap in order to get some downside protection," he said.

Pure leverage products with no downside protection were down 85% this month to $27 million from $178 million last month, according to the data, a sign that investors are shying away from non-protected products, sources said.

One possible reason for that, according to the structurer is that a lot of the money investors traditionally put into certificates of deposits is now being redeployed into notes.

"There is just no supply in CDs. The funding spreads make CDs less attractive. As a result, investors who would traditionally buy CDs are learning to consider credit risk. They want full protection but when they can't find it, they settle for partial protection," he said.

Interest rate levels drive demand for income products, the distributor said.

"Limited return and greater protection, I think that's what investors are buying right now," the distributor said.

"One of the main areas of demand is income.

"With Treasuries being where they are and the Fed pledging not to raise rates for the next two years, people are clamoring for yield," he said.

Bank of America with $53 million sold in three deals was the top agent last week, claiming 29.14% of the market shares. It was followed by Barclays and JPMorgan.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.