Yearly picture brightens despite slow holiday week; volume down only 1.62% compared to 2012

By Emma Trincal

New York, July 10 - The first week of the month coinciding with the Fourth of July made for tepid volume, but on a larger scale, issuance is gradually picking up, according to data compiled by Prospect News as well as sources.

Agents priced only $152 million in the week ended Friday, compared with $1.85 billion in the last week of June, according to the data. The number of deals dropped to 61 from 319. Sizes were particularly small; there was no deal over the $50 million threshold versus four the week before. Only one deal in excess of $20 million priced, compared with 19 the week before.

But the short July 1-6 period is showing a good start compared to last year's similar period with the same number of trading days, as volume is up nearly 30%, the data showed.

Another sign of improvement is the narrowing of the issuance gap between this year and last year. Agents had sold $19.27 billion as of July 6, a decrease of only 1.62% compared to the same time last year. At the end of June, the difference was 9%.

Improvements

"The volume is OK," a sellsider said.

"We're coming out of a period that was particularly bad. Part of the issue that we've had beginning in April and May was the fact that rates were so low.

"Now with this Fed tapering debate and uncertainty, we've seen more action and more choppiness in the market, so we now have more volatility, which was badly needed. You need volatility to monetize a structured product. If you have higher volatility, it helps. Now that we have that, volume is up."

A market participant and consultant in structured products, formerly with Charles Schwab, said that last week was probably not a good indication of the month to come in terms of sales.

"It was the first week of the month and the Fourth of July. Who wasn't on vacation? Obviously, you're not going to have a huge volume during those four days," he said.

"We've seen a tail off in price in the 10-year Treasury, a highly watched benchmark. I'm not certain that the other tenors have followed suit. The Fed is still controlling the short end of the curve. If you see rising interest rates on any other spot on the curve, it would certainly help."

From last month, the 10-year Treasury rate moved to 2.50% from 2.22%. Meanwhile, the one-year Treasury rate rose by only 1 basis point to 0.15%.

"While the rise of interest rates has been highly publicized, my view is that volatility has more of an impact on issuance than rates. It leads issuers to structure better returns, and it has an impact on investors' perception of the deals," the market participant said.

Fed deals

Rates-linked issuance is up 133% this year even though the size of this market remains limited to 3.5% of the total, according to the data.

Last week, rates-linked notes accounted for 16.65% of the total. They were ahead of single stocks, which made 15.5% of the volume.

"Rates have moved," said a structurer. "It's not going away. You're seeing more rates deals. This trend is more akin to the fashion of the day."

The top rates deal and the fifth of the week in size was Citigroup Inc.'s $9.12 million of callable leveraged CMS spread notes due July 9, 2033 linked to the 30-year Constant Maturity Swap rate and the five-year CMS rate.

The interest rate is 10% for the first year and 4.35 times the CMS spread thereafter subject to a minimum interest rate of zero and a maximum interest rate of 10% per year. Interest is payable quarterly, and the payout at maturity will be par. The notes are callable beginning on July 9, 2015.

Equity packaging

Last week also saw a number of notes linked to equity baskets combining indexes and exchange-traded funds.

One example was the No. 1 offering: Wells Fargo & Co.'s $24.17 million of 0% access securities with upside participation and fixed percentage buffered downside due July 10, 2017.

The underlying basket consists of the S&P 500 index with a 70% weight, the iShares MSCI EAFE index fund with a 15% weight, the S&P MidCap 400 index with an 8% weight, the iShares MSCI Emerging Markets index fund with a 4% weight and the Russell 2000 index with a 3% weight.

If the basket return is positive, the payout at maturity will be par plus 113.5% of the basket return. Investors will receive par if the basket declines by up to 15% and will be exposed to any losses beyond the 15% buffer.

The sellsider said that the use of those diversified baskets may be driven by pricing considerations.

"It's situation-specific. It depends," he said when asked if it was a trend.

"Adding different underlyings will cheapen volatility, and if the client buys volatility, they want it as cheap as possible. So adding elements to the basket will help with pricing."

Another deal of that kind, the fourth-largest one of the week, was Credit Suisse AG, Nassau Branch's $9.4 million of 1% coupon buffered securities due July 10, 2017 linked to a basket including the S&P 500 index with a 70% weight, the iShares MSCI EAFE index fund with a 15% weight, the S&P MidCap 400 index with an 8% weight, the iShares MSCI Emerging Markets index fund with a 4% weight and the Russell 2000 index with a 3% weight. The structure offers one-for-one participation in the upside capped at 59.7% and a 15% buffer on the downside.

"My perspective is that when you put together in a basket a bunch of liquid indexes and funds, you give investors the opportunity to get broad-based equity exposure in one package, which is something that they like. Investors are happy to use structured notes for access to asset classes or markets when they would have a hard time getting access to [them] on their own," the market participant said.

Year trends

For the year, equity indexes are down 2% and represent about 55% of the volume while single stocks have been on the rise, rising 12% to 22.5% of the total, according to the data.

Notes linked to baskets of stocks have increased by nearly 60%, but their market share remains limited to less than 2% of the volume.

Leveraged notes with no downside protection remained the most widely used structure this year, up 30% from last year and accounting for 21% of the notional.

Leveraged notes with barriers or buffers have dropped 11% to represent 17.3% of the total, closely followed by autocallable reverse convertibles (16.9% of the volume), which have nearly doubled, according to the data.

In the autocallable reverse convertible category are some "worst-of" deals such as last week's second-largest offering: JPMorgan Chase & Co.'s $10.35 million of callable contingent interest notes due July 8, 2016 linked to the least performing of the S&P 500 index and the Russell 2000 index.

If each index closes at or above its 60% barrier level on a quarterly review date, the notes will pay a coupon at an annualized rate of 7% for that quarter.

The payout at maturity will be par plus the contingent coupon unless either index finishes below its barrier level, in which case investors will share fully in the losses of the worst-performing index.

The notes are callable at par plus the contingent coupon on any quarterly interest payment date other than the first, second, third and final payment dates.

JPMorgan topped the league tables last week, pricing 12 offerings totaling $27 million, or 17.63% of the total. Wells Fargo and UBS were second and third, respectively.

"If you have higher volatility, it helps. Now that we have that, volume is up." - A sellsider

"Rates have moved. It's not going away." - A structurer

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