Sales drop amid headline-filled week although a stronger-than-usual bid on stocks helps

By Emma Trincal

New York, June 27 - Structured products issuance volume continued to weaken amid a volatile week ended Friday but investors showed a marked appetite for single-stock deals, taking advantage of attractive terms and opportunistic valuations, sources noted. Some said that the relative decline of equity indexes may need to be monitored as it could represent a shifting trend with investors feeling more confident picking names.

Volume down

"Overall issuance volume is down and it has to do with the uncertainty in the market," a market participant said.

"It's not great," a sellsider said. "Rates are so low; it's really tough to design products as attractive as they have been before.

"And then people stay in cash due to what's going on with the headline risk in Europe and its potential repercussion in the U.S," he added.

The third week of June saw volume drop by 43% compared to the second, with agents selling $250 million in 106 deals versus $441 million in 141 offerings the week before, according to data compiled by Prospect News.

"This decline last week makes total sense," a sellsider said.

"The market was anxious to see what the new ratings were going to be so it kept quiet.

"People had an idea and it got confirmed on Friday. But there was a lot of anxiety the day before," he said.

In what has become a refrain this year, the weekly volume decline is across the board and confirmed when looking at the monthly and yearly data.

Agents sold $1.29 billion as of June 23 this year, down 43% compared to $2.27 billion during the same time in April.

Sales dropped by 39% this month when compared to a year ago.

Finally volume is down 18% year to date with $18.28 billion so far in 2012 compared to $22.25 billion last year.

"I'm sure that the decline is even worse with capital guaranteed products compared to last year given how low interest rates are," the market participant said.

"Instead of principal-protected notes, people buy partial protection, index-linked products and single stocks," he noted.

Stocks do better

Stock deal issuance fared relatively better however.

In market shares, single-stock-linked notes continued to firm up relative to equity indexes last week with stocks making for 37.75% of the total while equity indexes amounted to less, a rare phenomenon based on past data, with 36.5%.

Stock products declined by only 7% to $94 million while equity linked notes collapsed, down by 65% to $91 million.

A comparison of this month to date versus the same period in May validates the relative decline in index products, which dropped by 56% versus a 4% decline in stocks, even if equity index remained bigger in notional amount - 53.5% of the total compared to 23.5% for stocks.

"These stats confirm my view on recent market developments: people are becoming more selective and see the value of structured notes as a replacement for the direct investment," the market participant said.

"If you want exposure to a stock, you can use a note that will change the payout profile giving you some additional upside and some kind of buffer. You might have to forgo dividends but overall, it might be more effective for you than holding the stock directly.

"It's actually a positive development as it shows that investors are more sophisticated.

"They used to look at index-linked products only, but now, they realize they can get exposure to stocks with a different risk reward trade off.

"I think it's a durable trend and that you're going to see more demand for single-stock-linked notes. We have to look at the next couple of months to see if this is not a fluke, but I believe we'll continue to see this," he said.

The use of stocks as an underlying, he said, is also driven by pricing factors.

"Dividend-yielding stocks give you more room to build better terms than the indexes, which tend to have lower dividend yields. Stocks are also more volatile and this usually translates into better terms too," this market participant said.

Thursday selloff

Last week was heavy with events from the Fed extending its Operation Twist program without a new round of quantitative easing to Thursday's selloff leaving the S&P 500 index down 2.5% for the day and pushing up the VIX index above 20 in a 16% increase for that day alone.

The market rallied on Friday after Moody's announced the downgrade of 17 banks, but overall the Dow Jones industrial average lost nearly 1% for the week.

More than a third of all the stock-linked notes of last week priced on Thursday, or 23 out of 61, according to the data. It was a day of surging volatility.

"Higher volatility makes those stock deals more attractive. Investors are waiting for that kind of event: now I pull the trigger and I invest. I want a certain level of coupon and this is the time to get it," the market participant said.

"It makes sense that many deals priced the day when volatility spiked. Striking these deals when volatility is high and valuations low is the right thing to do," the sellsider said.

In his view, the cloud of anxiety that kept investors on hold on Thursday ahead of Moody's downgrades had less of an impact on stock deal issuance.

"The banks downgrades caused less fear for those deals because reverse convertibles have shorter tenors. People care less about duration and credit risk exposure, which is also probably why you saw more stock than index products as index-based products tend to be longer dated," he said.

Apple continued to be a popular underlying with four deals last week, according to the data, among which were the No. 2 and No. 4 in size.

"Apple is a high-visibility, quality name. Apple is a very common underlying for reverse convertibles. People don't mind buying the stock and those are the investors that are willing and should be investing in reverse convertibles," the sellsider said.

Commodities

Commodities have regained strength based on the weekly and monthly data in the structured products space even if signs of a bear market have been perceived by some with the S&P GSCI Commodity index down 6% over the past month.

Last week, this asset class was the only one showing some growth, up 13% to $31 million. In market shares, those deals rose to 12% from 6% of the total.

Meanwhile recent commodities prices have posted steep declines, which many view as a reaction to the European crisis and deflationary expectations.

Commodities have also grown by more than 3.5 times month to date, accounting so far this month for nearly 10% of the volume with $127 million versus $35 million during the same period in May with 1.5% of the total.

"It's opportunity-driven," the market participant said.

"Commodities have been hit so hard, investors probably find some value and are more comfortable investing again at those levels. They get more protection than a direct investment and are often tied to a basket of commodities or an index, which allows then to spread the risk across the board."

But the sellsider said that he does not really see a particular commodities trend.

"It's probably because you happened to have a few more commodities deals last week. In dollar amount, this asset class remains relatively small compare to equities," he said.

Structures

The prevalence of stocks was reflected in the type of structures last week with 35% of the total in reverse convertibles, including pure trackers and callable reverse convertibles. Separately, 12.5% of the volume came from autocallables, which grew ten-fold to $31 million from $3 million the previous week.

Leveraged notes with partial protection remained the second largest type of structure with 14% of the total but declined by 73% to $34 million from $130 million the week before.

"If those leveraged deals are uncapped and volatility is up, you'll see less of those deals because the cost of leverage is more expensive," the sellsider said.

"You buy the option without being able to offset the cost with a cap."

The list of top deals was less impressive than usual last week with no offering in excess of $20 million. The top product was Wells Fargo & Co.'s $18.13 million of 0% growth securities with leveraged upside participation to a cap and fixed percentage buffered downside due June 26, 2014 linked to the Russell 2000 index.

The second largest deal was an autocallable brought to market by Bank of America Corp. with its $17.14 million of 0% Strategic Accelerated Redemption Securities due July 2, 2013 linked to the common stock of Apple Inc.

The annualized call premium based on the initial strike price and quarterly observation dates was 18.61% with a 10% downside protection.

UBS sold the third top deal with Royal Bank of Canada's $13.98 million of 7.24% reverse convertible notes due Dec. 31, 2012 linked to the common stock of MetLife, Inc. UBS was also the dealer for its UBS AG, London Branch's $12.64 million of trigger phoenix autocallable optimization securities due June 28, 2013 linked to Apple.

UBS was the top agent last week with $72 million sold in 54 deals for 29% of the total. It was followed by Barclays and JPMorgan.

Exchange-traded notes and certificates of deposits are not accounted for in this data.

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