Year starts on good footing in structured products amid equity rally, rollovers, bullishness

By Emma Trincal

New York, Jan. 11 - The year kicked off on an upbeat note compared to December as investors expressed more confidence in the market. An appetite for equities, a willingness to take on more risk, and rollovers were seen as the first noticeable trends of the new year.

Volume more than doubled in the first week of January to $578 million compared to the prior week of Christmas, which recorded a $279 million of volume, according to data compiled by Prospect News. Both weeks counted only four trading days. Those figures do not include exchange-traded notes.

Volume last week was up 61% from the first week of December, which recorded $358 million of sales. The number of deals last week was 57, compared with 98 deals in the first week of December.

Issuance more than doubled from the last week of the year, $279 million, to last week, a normal result given the holidays.

Compared to a year ago, however, the picture was less compelling. Last week's activity revealed a 46% decline from the $1.07 billion sold in the first week of 2011.

Rollovers

Sources, however, said that the year started on the right track.

"There's a lot of money coming due. A lot of deals are being called or matured. There's a lot of capital that has to be put to work," a market participant said.

"I think that we're going to see a big notional in the next couple of weeks."

Sources noted a renewed interest in equity-linked products, with the market showing signs of improvement as the year ended. The S&P 500 posted a nearly 1.5% gain in the first week of January. Sources said that investors expressed more optimism about the outlook of the European crisis and felt encouraged by the more positive macroeconomic data in the United States, especially the improved employment picture.

Equity-linked volume last week was up nearly 150% to $469 million from $188 million in the first week of December, according to data compiled by Prospect News.

Equity last week made for 81% of the total versus 52.5% in the first week of December.

Bulls out

"People are a little bit more positive. They're more bullish in taking on equity positions while remaining credit specific," the market participant said.

"So far, credit has been the biggest concern, but we're seeing some signs of improvement. Spreads for Bank of America and Morgan Stanley have come in. It helps. I think we're going to see a little bit more equity in the weeks to come."

The surge in equities was mostly felt with indexes, which more than tripled in volume to $384 million last week from $125 million in the first week of December.

Stocks month-to-month continued to grow but at the slower pace of about 45% to $85 million from $59 million during the first week of last month.

While equity-index underliers made for two-thirds of last week's volume, stocks represented only 14% of it.

"There's a fair amount of money coming out of equity-linked products probably going back into it," said Thomas Livingston, executive director at Halliday Financial Group.

"There was a fair amount of money put in this asset class in 2009, especially from Barclays, who did a big chunk of business then.

"If I had a 10-year bond that matures, I would probably reinvest it in another 10-year bond. The same goes with equity."

Risk on

Investors bought leveraged deals with no principal protection as well as digital payout notes and knock-in types of products such as equity-linked step-ups, according to Prospect News data.

Livingston saw in the bid for riskier equity products a natural trend in an environment of low interest rates.

"As we're on for an extensive period of low interest rates, at least until 2013, there really isn't a lot of alternatives than equity for folks looking for some kind of return, even if it's single-digit return," he said.

Sources observed that bullishness appeared to be taking hold now among investors despite the uncertain macroeconomic environment.

"I think 2012 is going to be more volatile than 2011. What's working today is probably not what's going to be working a month from now," said Livingston.

"I expect the European crisis to come to an end this year. We'll see something pretty ugly, but it's going to be brief. You can't keep kicking the can. The market can't tolerate it."

As a result, equities should be popular this year, he predicted. But investors need to pay attention to the structure they're buying.

"We think U.S. equities are going to outperform every other asset class in the next 18 months or so. We want to be long equity. But we understand that your equity return is going to be driven by structure."

The main structural trend was the willingness of investors to be less risk averse, sources said.

"We're seeing a lot of step-up business and a fair amount of leverage," the market participant said.

"There's a renewed interest in non-principal-protected structures because people are seeing the value of selling volatility.

"People went from CDs to notes and then from principal-protected notes to capital-at-risk notes. It's kind of the trend we're seeing, and we're pushing for it."

Top structures

Leverage without protection amounted to 27% of the total last week sold in seven deals totaling $157 million. It was a large increase from the $9 million that priced during the first week of December.

The top deal in this category, also the second largest one for the week, was HSBC USA Inc.'s $65.51 million of 0% Accelerated Return Notes due Feb. 22, 2013 linked to the S&P 500 index. The product offers three times leverage with a 17.82% cap. Bank of America Merrill Lynch was the agent.

Investors also bid heavily on a variety of step-up or STEP Income Securities offered by Merrill Lynch brokers to their clients. Those tend to give investors a digital payout that bumps up the return when the index closes within a range, which often is comprised between the initial price and the step level.

The main example, which topped the chart, was Bank of America Corp.'s $97.11 million of 0% autocallable enhanced market-linked step-up notes with buffer due Dec. 30, 2013 linked to the S&P 500. The notes will be automatically called at a 10% premium if the index closes at or above the initial index level on Jan. 18, 2013. If the notes are not called and the final index level is greater than the step-up value (132.5% of the initial level), the payout at maturity will be par plus the index return. If the final index level is less than or equal to the step-up value and greater than or equal to 90% of the initial index level, the payout will be par plus 32.5%. Investors will lose 1% for every 1% that the index declines beyond 10%.

Get it right

Livingston emphasized the importance of structure when picking a product.

"You can be right on whatever underlying you like, but you can [pick] the absolute wrong structure," he said.

"Even if you're right on your call, the wrong structure won't give you the right payout. For us, for instance, we have been looking for notes tied to specific commodities. But we're waiting to see the appropriate structure, and so far, we haven't.

"It's imperative you get the right structure in order to capitalize on the underlying," he said.

Bank of America Merrill Lynch was by far the top agent last week, pricing 83% of the total with 22 deals totaling $480 million.

It was followed by JP Morgan bringing to market two offerings for $38 million, or 6.5% of the total volume, and by UBS with $21 million, or 3.6% of the total, priced in 22 deals.

"There's a lot of capital that has to be put to work." - A market participant

"I think 2012 is going to be more volatile than 2011." - Thomas Livingston, executive director at Halliday Financial Group

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