Credit Suisse, RBC score big with absolute return notes; year-to-date volume is down 18%

By Emma Trincal

New York, Oct. 10 - Credit Suisse and Royal Bank of Canada topped the league tables last week. They brought to market absolute return deals that drew strong bids on the part of investors uncertain about the market, sources said.

Volume-wise, agents sold $262 million in 68 deals during the first week of October, a not-surprising decline from the last week of September, which recorded $1.8 billion in the sale of 293 deals, according to data compiled by Prospect News.

The first week of the month is not expected to be robust given the marketing cycle, sources said. Volume was roughly equal to the $260 million sold during the first week of September, according to the data.

Still, volume was relatively weak given that the first week of September was shortened and hampered by Labor Day.

Most significantly, the year-to-date issuance volume continued to post a decline. Issuers have priced $27.96 billion so far in 6,173 deals, an 18% decline from last year's volume of $34.07 billion achieved in 5,337 deals.

"Volume is down, period," a sellsider said. "It's not just structured products. There is just not enough investor confidence or conviction. You see the stock market volume shrinking as well. Volume is down in the high single digits in the equity market. It's all risky assets that are decreasing in volume. We're not the only ones."

A market participant agreed. "You have the elections coming up. You have Europe in crisis. Less volume: that's essentially the general market trend," he said.

Absolute return bid

Two noteworthy deals prevailed during last week's action in the form of absolute return structures built around a buffer rather than the more typical barrier.

The first, which was the No. 1 deal of the week, was Credit Suisse AG, Nassau Branch's $48.56 million of 0% absolute return barrier securities due March 30, 2015 linked to the S&P 500 index.

The upside is par plus the index return, capped at 20%.

If the final index level is less than the initial index level but greater than or equal to the knock-out level, the payout will be par plus the absolute value of the index return. The knock-out level is 80% of the initial index level. The notes offer a 20% buffer: once the index breaches that 80% threshold, investors will lose 1.250313% for every 1% that the index declines below the knock-out.

Another deal, smaller but similar in structure, was brought to market by another non-U.S. bank and represented the fourth largest offering of the week.

Royal Bank of Canada priced $19.38 million of 0% absolute return index-linked notes due March 30, 2015 linked to the MSCI EAFE index. The payout at maturity will be par plus any gain in the index, up to a maximum return of 20.05%.

If the index return is negative but not less than the knock-out amount - negative 20.05% - the payout will be par plus the absolute value of the return.

Otherwise, investors will lose 1.2508% for every 1% decline beyond the knock-out amount.

What some market participants noticed with those two deals was their common use of buffers with downside leverage rather than the more ordinary barrier.

"Those absolute return notes with a buffer are very old structures, actually," a structurer said.

"These are leveraged put spreads. It's a very old product sometimes called airbag, and that's how absolute return deals were designed in the beginning."

He explained that in order to obtain a 20% buffer with a negative leverage factor of 1.25 on the downside and a cap on the upside, the issuer used the dividends to buy a put spread. The trade consisted of buying an at-the-money put at 100, while an "1.25 put" was sold at an 80% strike. In order to finance the long put, the other leg of the trade, which creates the cap, consisted of writing a call.

This structurer said that the use of the buffer may just be a simple return to basics.

"Barriers are now much more in vogue. For some reason buffered structures have gone out of favor. Perhaps it is because the deep barriers have some appeal," he said.

Maybe investors realize the benefit of a hard buffer versus soft protection, he noted.

The strong bid on absolute return products was a positive sign, according to the market participant.

"We are seeing fewer and fewer principal-protected structures. The appetite for those absolute return notes indicates the increased sophistication of the clients. They are now accepting structured products as alternatives to the pure direct investments. By using structured products, they can alter the risk/return profile. Investors in general are getting more sophisticated," he said.

Those two deals are variations of capped knock-out structures, which suggest a sideway view of the market on the part of investors, sources said.

In those deals, investors bet on a range. They receive at maturity par plus the greater of the index performance and a minimum contingent return up to a cap when the index finishes above the knock-out; otherwise, they lose on a one-for-one basis from the initial price.

An example sold last week by JPMorgan was UBS AG, London Branch's $18.06 million of 0% capped index knock-out notes due Oct. 23, 2013 linked to the S&P 500.

The knock-out level was set at 19.65% below the initial price and could be triggered at any time. The cap is 15%, and the contingent minimum return is 5%.

Leveraged return notes with partial downside protection continued to be popular and amounted to 20% of the total in five deals last week.

The top one, and also the No. 2 offering of the week, was brought to market by RBC. It priced $34.46 million of 0% buffered bullish enhanced return notes due Oct. 5, 2017 linked to the S&P 500. The leverage factor on the upside is 1.2, and the buffer amount is 40% with losses beyond that accelerated by a factor of 1.66%. There is no cap.

Indexes

Another trend seen not only last week but for the entire year is the continued growth of equity indexes as an asset class.

Last week, notes linked to equity indexes made for nearly three-quarters of the volume.

For the year, equity indexes have increased by 18% despite the overall decline. They have been the underlier for $16 billion of notes, up from $13.5 billion during the same period last year. In market share, this asset class is dwarfing all others, grabbing 57.5% of the volume so far this year versus 40% last year.

Besides equity indexes, only exchange-traded funds have gone up in notional amount year to date, with a 14% growth from last year.

"It's a market following trend. Because the market has been up almost 13% this year, people want to have a broad market exposure. They want to participate in the market while they don't necessarily seek direct exposure to a particular stock," the market participant said.

"We see more action in equity indexes when times are uncertain," the sellsider said. "It's kind of odd to say that the market is uncertain when we had such a rally, but it's a very schizophrenic market," he added.

Top agents

The top players last week, Credit Suisse and RBC, were not the usual suspects.

Credit Suisse sold $79 million in just two deals, or 30% of the market last week. RBC, with $63 million sold in six deals, grabbed 24% of the market share and was the No. 2 agent last week.

An industry source said that it was due to the development of third-party issuers that have become able to distribute their own deals through their brokerage affiliates.

"These third-party issuers are becoming more acceptable. In the past, each firm was only the agent for its own deals. We now see more and more large distribution through the warehouses using third-party issuers either because of their good credit, like the Canadian names, or because they haven't been used that frequently," the market participant said.

But Credit Suisse and RBC acted as agents in their own deals.

The agent for Credit Suisse's $48.56 million offering, for instance, was Credit Suisse Securities (USA) LLC, an affiliate of the issuer.

RBC Capital Markets, LLC acted as agent for Royal Bank of Canada's $34.36 million deal, a leveraged buffered note linked to the S&P 500. It also was the agent for RBC's $19.38 million absolute return offering based on the MSCI EAFE index.

"They're not just issuers. They have their own distribution network, and they've had it for a while," the industry source said.

JPMorgan was the No. 3 agent with $47 million priced in seven deals, or 18% of the total.

"Volume is down, period." - A sellsider

"These third-party issuers are becoming more acceptable." - A market participant

© 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.