July so far is slow amid global sell-off, but sources say wait for the end of the month

By Emma Trincal

New York, July 29 – Summers are always sluggish for structuring desks, but it may be worse this year, at least so far, according to data compiled by Prospect News.

Sources attributed the change of pace to the bleak global picture. The Greek crisis earlier this month, the current meltdown in Chinese equities along with a bear market in commodities may finally begin to spook some investors, they said. Others say that it’s too soon to tell.

Agents sold $425 million in the week ended Friday, a 31% increase from the previous week but still a pretty weak number. The week’s notional ranks in the last quartile for the year’s weekly periods, according to the data.

A total of 102 deals were brought to market with four in excess of $20 million. There was only one over the $50 million mark.

It was Goldman Sachs Group, Inc.’s $63.5 million of three-month notes linked to the MSCI Europe index.

Weaker July

July action has been lackluster compared to June, which is consistent with previous seasonal trends. However, this month so far is little more than half as busy as July of last year.

While the month is incomplete, figures from July 1 through July 24 already point to a 22.5% decline from a strong June with sales falling to$1.24 billion from $1.60 billion last month.

A look at volume a year ago suggests that the decline may not just be seasonal. Issuance is down 55% for July 1 through July 24 compared to the $2.72 billion that priced during the same period in July 2014.

“July last year for us was a good month. This year, not so much,” a market participant said.

“It’s pretty much standard. Typically summers are slow. Last year may have been the aberration rather than the norm.”

The July slowdown has already had an impact on year-to-date figures, which is not unusual as the summer kicks in.

Volume for the year to date has now grown 8.92% to $26.20 billion from $24.05 billion. A few weeks ago, the year-to-date volume was up 15% from last year.

“Let’s see what the next couple of days will be like,” a sellsider said.

“We did lose a week in July with Greece. It’s not like we couldn’t price deals. People wouldn’t want to trade. But we see a back end of the month pick up. We have to see what the final part of the month looks like before we can draw conclusions.”

Macro trepidation

While slow for issuers, the market as a whole was far from boring.

“Volatility has increased,” the market participant said.

“You have the Chinese stock market collapse, a sell-off in emerging markets, commodities in bear market territory.

“But all that should get people to look at structured notes as a way to get some protection while they have the exposure. Apparently it has not been the case or at least not yet.”

From Wednesday last week to Monday, the CBOE Volatility index, which measures near-term volatility on S&P 500 index futures, rose 30%.

“The blessing in the curse of the macro events is that the market has a little bit of volatility,” the sellsider said.

“When you sell volatility and volatility is higher, the economics are better. Different sectors or underliers are better than others, but you can definitely get better terms.”

Pricing

Some sources, including on the buyside, are expecting to see more attractively priced deals.

For instance notes linked to the S&P 500 have routinely disappointed financial advisers who are averse to caps and want buffers. The reality has often been longer-dated deals in order to remove or increase the cap while in some cases introducing some amount of protection.

But now that volatility is picking up, some plain-vanilla structures may become more appealing, sources said.

The second-largest offering to price last week offered an example. Credit Suisse AG, London Branch priced $46.08 million of two-year leveraged buffered notes linked to the S&P 500 index. The upside was levered at a rate of 1.5 up to a 20% cap. A 10% geared buffer with a 1.11 multiple offered some downside protection.

“We did a note last month. It was a 14-month S&P with 300% leverage to a 12% cap and one-for-one exposure on the downside,” the market participant said.

He compared those terms with the Credit Suisse deal’s features.

“By adding a 10% geared buffer, reducing the leverage, slightly lowering the cap and extending it to a two-year ... they were able to do it. It all adds up,” he said.

Geared buffers

This source praised leveraged buffers as a unique way to improve the terms of a structure when the underlying asset is not very volatile.

“The geared buffer is somewhere in between a standard buffer and a barrier. I kind of like it. We don’t do it because it’s not approved on our platform. I’d like to get it approved. It’s easy to use. It’s not hard to understand if you explain it well. And it allows you to really get better terms,” he said.

There are not many deals with geared buffers in the market in general, he noted.

“I would assume that other banks may have some restrictions as well,” he said.

“If you introduce a geared buffer, your product will be considered a new structure, and those need to be approved by the regulators.

“It’s understandable that they would want to approve it. One of the things regulators keep a close eye on is the complexity of a structure, whether advisers are trained and understand what they’re selling and if the end user understands the product.”

Commodities, rates

Last week’s issuance included fewer equity-linked notes. Equity, which includes single stocks, baskets, exchange-traded funds and indexes, made for 76% of the total volume versus 86.5% on average for the year, the data showed.

“It’s not so much that money is moving away from equity, but we’re seeing an increased interest in the commodity side,” the market participant said.

“Even though it’s a little bit like catching a falling knife people still want to get exposure there. Doing it through a note gives you that downside protection that makes it more comfortable even though you might get in too early.”

Six commodity-linked notes offerings were brought to market last week totaling $35 million, or 8.27% of the total, more than the 2.78% average market share for the year.

The top one was Bank of America Corp.’s $20 million commodity-linked notes tied to the Bloomberg Commodity Index 2 Month Forward Total Return with a 300% upside participation rate.

The sellsider said he does not anticipate a lasting trend.

“I don’t think we’ll see a lot of it. People got beaten up on commodities. It takes a very sophisticated, tactical sort of bearish investor to do it,” he said.

Flatter curve

Another non-equity deal, the third one in size last week, was a 12-year rate product. Wells Fargo & Co. priced $26.73 million of fixed-to-floating-rate notes linked to the 10-year Constant Maturity Swap rate.

The interest rate was 4% for the first three years. After that, the floater would be 0.88 times the 10-year CMS rate. The payout at maturity was par.

Steepeners based on the spread between a longer-dated CMS rate and a shorter-dated one, for instance a 30-year CMS minus a two-year, have become less common, observed the market participant.

“I can see why people would be looking at a floater if you anticipate that interest rates are going to rise. You don’t want a steepening structure because rising rates typically mean a flattening of the curve. So steepeners would not be the place to be,” he said.

“At the same if you do a steepener right now, you’re going to get very attractive terms to offset the risk of a flattening curve.

“You can see bigger multiples on a 30[-year CMS rate] minus two[-year CMS] spread. You may see instead of four times, six, seven or eight times in order to take into account the current flattening of the curve and the possibility that it could get flatter.”

The top agent last week was Goldman Sachs with seven offerings totaling $111 million, or 26% of the total. It was followed by JPMorgan and Credit Suisse.

“We have to see what the final part of the month looks like before we can draw conclusions.” – A sellsider

“...[I]f you do a steepener right now, you’re going to get very attractive terms to offset the risk of a flattening curve.” – A market participant

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