Volume declines by more than half; sell-off seen as missed opportunity for discounts

By Emma Trincal

New York, June 26 - Given last week's sell-off, the lackluster issuance volume seen in the week ended Friday came as a surprise, sellside sources said.

Agents sold $228 million last week in 82 deals, a 52% decline from the previous week, which recorded $476 million in sales, according to data compiled by Prospect News.

There were only seven offerings in excess of $10 million, versus 13 the week before. No deals over the $20 million size threshold were issued last week while the prior week saw the issuance of six of them, the data showed.

Missed opportunity

"I think it's puzzling," a sellsider said.

"Typically, higher volatility means that structured notes can offer better terms, therefore one would think this is an opportunity for people to enter the market since terms were more attractive than what we've seen in the weeks before.

"Generally speaking, when the market has been rallying as it has been lately, people want to participate, and a pullback is usually welcomed and used as an opportunity. It's interesting that conditions were there to have greater volume but clearly the outcome was different. In fact, we've seen less volume. I'm not sure I know why," he said.

On Thursday, the S&P 500 saw its biggest decline for the year. The benchmark lost 3.6% in the two trading days following Fed chairman Ben Bernanke's hint on Wednesday that the bond purchasing program may be scaled back at the end of the year. Meanwhile, the 10-year Treasury yield rose to 2.572% on Friday, its highest closing level in nearly two years.

The market had a negative response to Bernanke's comments, focusing on the consequences of an eventual end to quantitative easing, which many have said was the main driver behind the rally, sources said.

In addition, signs of weakness in China last week aggravated the sell-off.

Volatility surprise

Volatility as measured by the VIX index peaked at more than 21 on Thursday, its highest level this year.

"The pickup in [structured products] volume hasn't happened. Stocks sold off quite a lot last week, but the longer-dated volatility hasn't picked up very much. It's a bit of a surprise," Tom May, partner at Catley Lakeman Securities, said.

"That might be one reason why we haven't seen issuance volume rise. Volatility has not responded as much as you might expect. Now the market is in rally mode again. It's hard to say if there will be a lag and if we will see more volume this week or not. No one can really tell."

The sellsider made a similar observation.

"Longer-dated implied volatility generally doesn't move as much as shorter-dated volatility," this sellsider said. "Perhaps the difference was not substantial enough to make it compelling. But still. It still doesn't quite explain why there is such a lack of enthusiasm among investors when they had the opportunity for discounted levels.

"In general, we haven't seen a strong participation in the structured products market lately.

"Partially it could be driven by the fact that broker-dealers are more focused on dealing with regulatory attention, they're more preoccupied by it as opposed to selling products.

"Nonetheless, it's still hard to explain why we haven't seen a pickup in volume last week after such a market slide.

"It will be interesting to see how the big boys finish the month, guys like Bank of America, JPMorgan. They generally have comparable offering levels from month to month.

"In that sense, they could create an indicator of investors' sentiment so we could get a sense of what's weighing volume down."

Volume down for month

Volume also disappointed on a month-to-month basis. Agents have sold $1.12 billion in June as of the 21st, a 24% decline from the same period in May, according to the data. Meanwhile, the number of deals remained stable at 353 so far in June, compared with 350 last month.

Sales fell 18.65% from $1.37 billion in the same period in June of last year.

All asset classes declined in volume last week except for commodities, which were up nearly 45%. The increase was due to one deal out of two, which was the second in size for the week. It was Citigroup Inc.'s $13.7 million of 0% barrier plus securities due Dec. 16, 2016 linked to a basket of two commodities (copper and gold) and four commodity futures contracts (Brent crude oil futures, RBOB gasoline futures, corn futures and soybean futures).

The upside offered an upside leverage factor of 1.87 applied to the basket return, while the downside featured a 70% barrier.

Protection or not

So far this year and also this month, leveraged notes with full downside exposure have prevailed over leveraged products with a barrier or a buffer, a consequence of investors' confidence in the rally, some sources said.

Last week, the trend switched the other way around, but sources said that market conditions may not be the cause for the reversal.

Leveraged notes with partial downside protection were the top structure last week, accounting for 31% of the total versus only 6.7% for leveraged products that offered no protection, according to the data.

For the year, however, it is the opposite: 21% of the volume comes from unprotected leveraged deals versus less than 16% from partially protected leveraged notes.

"I don't think this is market-driven. I think it depends on the channel you're looking at," the sellsider said.

"Looking at the RIA channel, they like buffers. They'd rather have a longer maturity but with a buffer. RIAs typically want that.

"Going to the large networks like Merrill Lynch, they don't necessarily need buffers. They do accelerated return notes instead of a buffer. They try to have more leverage or higher caps. It's just a more bullish approach.

"There are reasons behind those choices. RIAs for instance prefer buffers because they use structured notes as allocators, looking at their overall portfolio.

"Those buffered notes turn into rollovers easily. People who buy them tend to like them. The only time you underperform is when the benchmark rallies a lot, but even then, people may still be happy depending on where the cap is.

"But for the Merrill Lynch and the likes, what often drives those products is the fact that they're using their own research. If the research is positive, there's no specific reason to put a buffer.

"So it's a little bit of a different flavor. It depends on what type of distribution channel is going to prevail on any given week."

Top deals

The largest deal of the week was a buffered leveraged and capped note brought to market by Morgan Stanley. The firm priced $13.77 million of 0% Buffered Performance Leveraged Upside Securities due June 24, 2016 linked to the Russell 2000 index. The notes offer a 150% participation rate on the upside up to a 58% cap. The downside is protected up to 10% by a hard buffer.

Goldman Sachs Group, Inc. brought to market a digital note, the third largest offering of the week, in its $11 million of 0% index-linked digital notes due Aug. 21, 2014 linked to the Euro Stoxx 50 index.

If the final index level is greater than or equal to 90% of the initial level, investors will get a digital payout of 9.1%. If the index finishes below 90% of the initial level, investors will lose 1.1111% for every 1% loss beyond the 10% buffer.

The fourth largest deal was an autocallable reverse convertible, a structure that has nearly doubled in volume so far this year.

It was Morgan Stanley's $10.75 million of contingent income autocallable securities due June 26, 2014 linked to lululemon athletica inc. shares. The structure features a contingent quarterly coupon at an annualized rate of 12% if lululemon stock closes at or above a 70% downside threshold level on the determination date for that quarter. The notes are automatically called if the stock closes at or above the initial share price on any of the first three quarterly determination dates.

If lululemon stock finishes at or above the downside threshold level, the payout at maturity will be par plus the contingent payment. Otherwise, investors will receive a number of shares of lululemon stock equal to $10 divided by the initial share price or, at the issuer's option, the cash value of those shares.

The top agent last week was Morgan Stanley, which sold seven deals totaling $50 million, or 21.83% of the total. It was followed by JPMorgan and Barclays.

"The pickup in volume hasn't happened. ... It's a bit of a surprise." - Tom May, partner at Catley Lakeman Securities

"I think it depends on the channel you're looking at." - A sellsider on whether leveraged notes with protection or without are more prevalent

© 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.