Despite strong week, volume falls 7.41% for year due to fewer stock-, commodity-linked notes

By Emma Trincal

New York, May 1 - Issuance of structured notes excluding exchange-traded notes dropped 7.41% to $11.96 billion for the year to date from $12.91 billion last year, according to data compiled by Prospect News for the Jan. 1 to April 27 period.

The number of offerings declined 10% to 2,574 from 2,862 during that time.

The weaker volume was partly due to a decline in notes linked to single stocks (down 5%) as well as drop in products linked to exchange-traded funds (down 33%), according to the data. Another major contributing factor was the issuance of commodity-linked notes, whose volume plunged 35% to $791 million so far this year from $1.21 billion last year.

Meanwhile equity index-linked notes issuance remained flat. Their total is $6.60 billion this year, up only 1.17% from the $6.52 billion priced last year.

For the year through April 27, the main structural trends were an increasing volume in leveraged notes with no downside protection and an uptick in autocallable reverse convertibles. Both product types saw their volume nearly double year over year.

"We're down for the year. It seems to be the trend. It is what it is. A 7.4% decline is not catastrophic. But we had a good beginning of the year, so we're definitely hitting negative territory," a structurer said.

Sources said that the decline in volatility was not helping.

"Aside from occasional spikes, volatility is down across the board," a sellsider said.

"The general trend from a year ago is that volatility has decreased. Investors are seeing the market doing fairly well."

Lower volatility levels may in some cases explain why some structures are more popular than others.

"Because the market is up, maybe there's less reliance on the buffer and people are looking for more upside," this sellsider noted.

"Also, the low volatility makes it difficult to implement the buffer."

Cap or no cap

The structurer said that the use of buffers or not had a lot to do with pricing.

"I wouldn't read too much into the changing trends. Some weeks you see a lot of leverage with no downside protection, and other weeks, you see more barriers or buffers," he said.

"It's a matter of pricing. You can always have a buffer, but you'll have to pay for it with less leverage or a lower cap.

"Ultimately, it depends on what people want to do, on what their convictions are. If a bullish investor wants to eliminate the cap, he may have to forego the buffer."

Leverage with no downside protection represented 22.23% of the overall market this year, according to the data. Volume in this structure type was up 91%. Meanwhile, leverage with either a buffer or a barrier, which made for 17% of the volume, declined by 23% year to date.

The decline was related to the subdued volatility, the structurer said.

"When volatility is low, leverage with no cap is more attractive," he said.

"On the other hand, you see reverse convertibles becoming less attractive in these conditions.

"These pricing factors may explain why you see more leverage with no cap and less reverse convertibles when volatility is low."

Part of investors' decisions in choosing the structures they want depends on their market outlook, he added. Less volatility and rising equity prices may prompt investors to stay away from structures that cap their returns, such as reverse convertibles or leveraged capped notes, he said.

"The decline in single-stock issuance is related to the decline in traditional reverse convertibles. Reverse convertible is less of a growth play. By selling the put, you have a fixed return and you also have all the downside. It's more like a single-stock play," the structurer said.

"At the contrary, leverage, which we see more in this market, reflects a need to play the upside. You want in your transaction the market to go up. It's more the reflection of a bullish view."

Finally, the reduced interest in stock underliers may be driven by the way investors use structured products in general, he said.

"Sometimes we see the stock deals spike, but the bigger trend is that the majority of the notes is tied to indexes," the structurer said.

"Investors tend to express a view on equities in general. They're not so much betting on a sector or name. It's based on a general conviction. The trend is more toward market picking than stock picking.

"People have been using structured products as an asset allocation tool and continue to do so. Sure, stocks like Apple have been a darling. But right now, I see more interest toward asset allocation."

ETFs

The volume of products linked to equity ETFs fell to $490 million from $726 million last year, according to the data.

"A lot of ETFs are index ETFs. Basically, you use them when the index futures contracts on the index are less liquid. For instance, Nasdaq futures don't have the liquidity of the S&P futures, so as a manufacturer, I would have to find an alternative to hedge the Nasdaq. That's when it would make sense to use the QQQ," the structurer said.

"But the S&P 500 is by far the most well-known and most-used index. It's used by default. It's the underlying people use when they don't have a strong conviction in the market. When in doubt, you use the S&P, and that's what we're seeing right now."

For the sellsider, the less favorable environment for stocks could be because Wall Street is running out of good names to pitch.

"In order to be successful when issuing single-stock deals, you need a couple of standout companies. In the past, we used to have good success stories with Apple or Ford for instance. Maybe we're not seeing as many of these big success stories right now," he said.

"It's a bit more company-specific when you have a big reverse convertible. If a company really strikes a chord with investors, you will see some big volume.

"But we don't seem to have that many companies like that right now, companies that are well covered in research, big in the news and that capture investors' interest."

Top agents

Bank of America was the top agent last week with 15 deals totaling $373 million, or 43.5% of the volume. It was followed by UBS and JPMorgan.

Bank of America Corp. priced the top deal with its $93.68 million of 0% Accelerated Return Notes due June 27, 2014 linked to the S&P 500 index.

The structure offered three-times upside leverage subject to a maximum payout of par plus 11.7%. Investors were subject to the full downside risk.

The second-largest deal, also a leveraged note with no buffer, offered a two-month look-back feature.

Bank of America priced $49.54 million of 0% Accelerated Return Notes due April 24, 2015 linked to the S&P 500.

The initial index level would be the lowest closing level of the index during the two-month period that began on the pricing date.

If the index return was positive, the payout at maturity would be par of $10 plus 300% of the index return, subject to a 16.45% cap. Investors would lose 1% for every 1% decline in the index.

The third-largest deal, also sold by Bank of America, was a leveraged buffered note. HSBC USA Inc. priced $37.02 million of 0% Capped Leveraged Index Return Notes due April 24, 2015 linked to the S&P 500. The structure offered two-times upside leverage capped at 12.44% with a 10% buffer on the downside.

"We're down for the year. It seems to be the trend. It is what it is." - A structurer

"When in doubt, you use the S&P, and that's what we're seeing right now - A sellsider

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