Year ends with second-slowest week of the year for structured products, weakest month of 2012

By Emma Trincal

New York, Jan. 2 - The last week of the year ended on a soft note with $122 million of structured products sold in 61 deals, an 86% decrease from the week before, which came as no surprise given the combination of the holiday break and the fiscal cliff sell-off, sources said.

It was the second weakest week of the year, after the week of the Fourth of July, which saw only $110 million in sales, according to data compiled by Prospect News.

Even though sales from Monday through Friday last week did not include Monday, Jan. 31, most of the monthly sales had been priced by Friday.

"We're done for the month," a market participant said.

December was the slowest month of 2012 with $1.67 billion sold in 514 deals, a 31% decrease from the same time in November, according to data compiled by Prospect News. July was the second-weakest month with $2.16 billion priced in 553 offerings.

Good outlook

Sales on the year to date as of last Friday were down 16% to $34.72 billion from $41.32 billion during the previous year.

"2012 was a tough year," a structurer said.

"There were a lot of issues in Europe, which potentially could have triggered more issues in the rest of the world. Investors had to face a lot of uncertainty. In this kind of environment, it's pretty much safer to invest in bonds or bond funds.

"But it could change in 2013 because bonds have become very expensive and there is a lot of juice in equity, making the economics of the deals much better. Last year, investors had to deal with a lot of uncertainty in Europe and in the U.S. But these issues are more or less going away now. There is no presidential election ahead of us. Most investors think that we are close to the end of the tunnel."

The sellsider shared his optimism.

"A lot will be rolled up in January. We're looking at a big January as usual. A lot of stuff is coming up," he said.

Besides the holidays, the fiscal cliff sell-off last week did not help as investors anxiously waited for the outcome of the fiscal cliff negotiations.

The S&P 500 fell by nearly 2% last week and the VIX index rose by 22% above the 20 threshold to 21.79 from 17.84.

"Nobody would want to buy notes in the middle of this drama, when you have no idea if Congress is going to allow us to go over the cliff," the sellsider said.

"The market was very unstable and as the issue came to resolution this week, we've seen a big rally, first on Monday and then [Wednesday] as a follow-up."

A sign of weakness last week was the number of deals in excess of $10 million - down to three versus 23 the week before.

Top deals

The No. 1 offering was a simple delta-one product with a particularly short tenor.

Goldman Sachs Group, Inc. priced $70 million of 0% notes due April 4, 2013 linked to the Topix index. The payout was par plus the index return, with investors being fully exposed to losses.

The second top deal was a callable reverse convertible tied to a popular stock. It was Deutsche Bank AG, London Branch's $22.59 million of trigger phoenix autocallable optimization securities due Dec. 29, 2017 linked to the common stock of Apple Inc. UBS was the agent.

If Apple stock closed at or above the trigger price - 65% of the initial share price - on a monthly observation date, the issuer would pay a contingent coupon at the rate of 10% for that month.

The notes would be called at par of $10 plus the contingent coupon if the shares closed at or above the initial price on a quarterly observation date.

If the notes were not called and Apple shares finished at or above the trigger price, the payout at maturity would be par plus the contingent coupon.

Otherwise, investors would be fully exposed to any losses.

Callable reverse convertible issuance grew at a very fast pace last year, doubling up to $3.77 billion from $1.9 billion in the previous year and making for nearly 11% of the total from less than 5% in 2011.

Callable notes

Among last week's most popular were callable reverse convertibles and leverage notes with a buffer or a barrier.

"The popularity of those callable notes doesn't surprise me given clients' search for yields," said the structurer.

"That's the same logic behind the popularity of bonds and bond funds as well as MLPs lately. It's a smart way to be able to generate yield. It's also a function of your market view. Investors in these products tend to see the market trading in a range. You don't have to be really bullish. You just have to not be bearish."

He said that the popularity of leveraged structures with partial downside protection via buffers or barriers was also not surprising.

"It's kind of an enhanced delta one structure. You have a buffer on the downside, but you can still get an enhanced upside. It's a different bet than income products. We're not talking about yield. It's an alternative to a delta one strategy.

"In general we see a lot of different opinions around structured products - reverse convertibles, leveraged notes, worst of etc.

"My take is that there's no bad payout. There is no bad bet. A bad bet is when you don't understand your bet.

"Even a worst of is not a bad bet if you are confident in the stock and if you understand the structure," he said.

Fear of stocks

Due to the Deutsche Bank product tied to Apple, the percentage of single-stock-linked structures at 35.5% was unusually close to the proportion of equity-index notes, which was 38.5% of the total.

Stocks in general have been hit the most in what remained an equity-focused year. While the issuance of equity-linked notes showed some resilience compared to all other asset classes (they declined by only 3.5% during the past year), this result was mostly due to a strong growth in equity index deals, which were up nearly 14% in volume rather than to single-stock growth as those saw their volume drop by 31.5%. Notes tied to equity exchange-traded funds did not do well either, down 16% to $1.78 billion from $2.13 billion.

"It was not an easy market last year, and if you're afraid of the equity asset class as a whole, it's getting more difficult to make stock-picking bets," the structurer said.

Unusual accrual

The third deal surprised some for the category of product being sold - a range accrual type of structure and one that has not been seen a lot lately.

Goldman Sachs priced $17.57 million of callable monthly Russell 2000 index-linked range accrual notes due Dec. 31, 2022.

The interest rate was an applicable rate multiplied by the proportion of days on which the index closed at or above the index trigger level, which was 70% of the initial level. Interest was payable monthly. The applicable rate was 8% for the first 48 months and would step up to 10% for the next 36 months and to 12% for the final 36 months.

If the final index level was greater than or equal to 50% of the initial level, the payout at maturity would be par. Otherwise, investors would be fully exposed to losses.

"It's a very nice trade. It's a buy-and-hold type of trade. It may be a little choppy on a mark-to-market basis if we have a pullback or an increase in volatility," the sellsider said.

"The payout profile seems to be fairly compelling. Goldman is a fairly wider funder, that's probably reason number one. Number two, those range accrual [structures] are still a new product. It's a range note with principal at risk. It will take some time for this type of product to be accepted. You don't want the traditional fixed-income investor to buy it without understanding what it is."

The top agent last week was Goldman Sachs with $92.35 million or 75.5% of the total in four deals.

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