Structured products hit by weakness as investors focus on Uncle Sam; volume is $195 million

By Emma Trincal

New York, April 25 - Volume continued its decline this month as April's tax deadline was on investors' minds, sources said.

Investors meanwhile continued to be willing to take on risk for additional yield and bid on callable reverse convertibles and notes with contingent protection instead of buffers, according to data compiled by Prospect News.

Issuers priced $195 million last week, down 67% from the week before.

Compared to the same period in March, the decline was 39%. Issuers priced $993 million from April 1 to Friday. Volume month to date fell by nearly 43% compared to a year ago.

"It's not pretty!" a structurer said.

Sales fell by 27.5% year to date to $11.11 billion from $15.34 billion last year.

Agents this year have been pricing deals that are smaller in size. So far, 23 deals over $50 million in size have been sold versus 59 during the same time last year.

These figures do not take into account exchange-traded notes and certificates of deposit.

Tax impact

"April has always been historically a difficult month," the structurer said.

"It's tax time. Clients are more interested in seeing their accountant than their financial adviser.

"It's a harder time to sell something, particularly in a market that has been definitely boring because [it's] either flat or surrounded by negative news."

All asset classes fell month to month except for rates-linked notes, which grew 45% to $81 million from $56 million. However, this is only 8% of the month-to-date total.

Rates deals in this count do not include lightly structured notes such as step-up notes, fixed-to-floating notes and capped floaters.

In terms of structures, the data confirmed what many buysiders have been noticing: issuers are offering fewer buffers, replacing them more and more with contingent protection, also known as barriers.

Out of the 93 deals priced last week, only 13 were buffered notes. The buffers ranged from 5% to 20.25%. Most of those deals had a 12- to 18-month tenor.

Some observers, such as Andrew Valentine Pool, main trader at Regatta Research & Money Management, said that they can't find their desired buffer sizes in this market.

"We like enhanced notes on indexes better but with larger buffers. My partner showed me an 18-month with a 10% buffer on the S&P 500 and I was against it. It's not enough," he said.

Some believe that the predominance of barriers may be a function of investor choice.

"People still like the buffer idea. But it's just more expensive because it gives you protection regardless. If you believe that the market is trading range bound or up, you may think that you're wasting money with a buffer and that all you really need is the contingent protection," the structurer said.

It's not just the notes market that is going through a difficult time, a market participant said.

"Issuance has been a little bit difficult on CDs because rates have come back in," he said.

"The 10-year Treasury was at 2.35% a few weeks ago. Now it's under 2%, putting pressure on funding levels.

"My guess is that CD issuance year to date is probably down 25%. It's not just the notes business. It's true for all structured investments."

For the structurer, the problem may be even broader.

"I think people are on hold. The structured products market is going through a correction, and this year will be difficult. We'll go through a rebalancing," he said.

"The whole market is slowing down. Europe is heavily weighing on the minds of investors, with yields rising in Spain, Italy and the presidential elections in France. Then there is the looming Middle East crisis, without even mentioning the U.S. elections. A lot of things are going on.

"You'll see U.S. investors using structured notes for more tactical plays with products linked to a specific asset class or name."

Beloved Apple

An example of this was last week's largest deal, Morgan Stanley's $32.56 million of contingent income autocallable securities due April 20, 2015 linked to the common stock of Apple Inc.

Investors will get paid 3.25% on a quarterly basis if the closing price on the observation date is at least 75% of the initial price. If the price is above the initial price on the observation date, they will get called and will receive par plus 3.25%.

The payout at maturity in the absence of a call will be par plus the final coupon if the final share price is at least 75% of the initial share price or a number of Apple shares equal to par divided by the initial share price if Apple stock falls by more than 25%.

All structure types declined in volume, but one - which Morgan Stanley used in this Apple offering - did better than others. It was the callable reverse convertible type of product, a hybrid of reverse convertibles and autocallables.

For the month to date, for instance, the volume of deals falling into this category was $154 million, up 30% from last month, and made for 15.5% of the total. The growth so far this month compared to the same time a year ago is 313%.

In comparison, the traditional reverse convertible, which accounted for 11% of the total a year ago with $185 million, has dropped by 62% this month to $71 million.

The decline may reflect investor skittishness after losses incurred when the market fell last summer.

"I don't even look at reverse convertibles," Pool said.

"I strictly stick to enhanced growth or principal protected. Reverse convertibles have bitten too many of our clients who are not happy.

"It only makes sense if the investor wants to own the stock. But our clients don't have the appetite for that. They're older. They want to keep their principal."

The structurer said that callable reverse convertibles offer advantages versus the classical version of the product.

"It takes the multiple legs of a reverse convertible and simplifies it," he said.

"The European option adds a lot of value, and when those deals are autocallable, it takes away a lot of the uncertainty because you know when you're going to get called."

Not good-looking

In general, though, most structures and asset classes remained invariably the same.

Some suspected that clients may be unimpressed with the supply being offered.

"Because rates have come in, the structures of the deals have not been as attractive as they were a few months ago. Some clients are used to better-looking deals," the market participant said.

"It's been tough to print innovative deals. A lot are similar to what was done last year. We see some rollover, but there is still some new money coming in."

Leveraged notes with partial downside protection this month have dropped by 18% from a year ago and by 43% from last month.

However, on a year-to-date basis, these types of deals have continued to attract dollars. They're up 12% at $2.22 billion, amounting to 20% of the total versus 13% last year.

One example was the No. 2 deal of the week, which was sold by UBS Financial Services Inc. HSBC USA Inc. priced $16.61 million of 0% buffered return optimization securities due May 23, 2013 linked to the S&P 500 index. The structure features two-times leverage with an 11.62% cap on the upside and a small buffer of 5% for the downside.

Also popular is the market-linked step-up structure, a specialty of Bank of America, which sells them for itself or other issuers. The success of this product suggests that investors are not unwilling to take downside risk with a barrier when the upside potential seems to be worth the risk.

In the third largest deal of the week, HSBC issued $13.42 million of market-linked step-up notes due April 29, 2016 linked to the MSCI Emerging Markets index. Bank of America Merrill Lynch was the agent.

Investors receive an enhanced upside in the form of a step-up payment of 48% if the index finishes above the initial level but below the 148% step level. Above the step level, investors get unlimited upside. The trade-off is the full exposure to losses if the index ends below the initial level.

Investors do not get any downside protection in the form of a buffer, but the advantage is the upside potential, noted Pool.

"That's obviously money that wants to take risk. Although it seems nice to be able to make 48% when the fund is up only 2% for instance, it's still risk money and it would be a small portion of our portfolio if we were to consider it," he said.

JPMorgan was the top agent last week with $41 million sold in eight deals, or 21.22% of the total. It was followed by Morgan Stanley and Barclays.

"My guess is that CD issuance year to date is probably down 25%. It's not just the notes business." - A structurer

"I don't even look at reverse convertibles." - Andrew Valentine Pool, main trader at Regatta Research & Money Management

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