Outlook 2012: Year may be turning point after strong boom in post-Lehman era, sources say

By Emma Trincal

New York, Dec. 30 - Issuance continued to grow in 2011 but at a much more moderate pace than the year before, making a mixed impression on market participants and their predictions for what to expect in the coming year.

On the one hand, some were happy to see growth given the difficult market conditions of 2011. On the other hand, the slowdown from the previous year was unmistakable.

Agents had priced $40.59 billion of U.S. structured notes, excluding exchange-traded notes, in 2011 as of Dec. 23, a 2.17% increase from the comparable period the year before, according to data compiled by Prospect News.

But such growth was not much compared to the nearly 40% increase in volume seen during the same period between 2009 and 2010.

The number of offerings rose by 9% to 6,851 in 2011 from 6,277 the year before, a very subdued increase compared to the 51% increase from 2009 to 2010.

Lehman Brothers is over

"I'm glad to hear we're up for the year compared to 2010. The increase in volume that we have this year is encouraging. It's more important to look at the volume than the number of deals. Volume surged in 2009 and 2010. But keep in mind that this was atypical. The years 2009 and 2010 represented an anomaly because those were the post-Lehman Brothers years," said Samson Koo, head of derivative products at Advisors Asset Management.

"Also, we had the European debt crisis this year, which hasn't been good for U.S. structured products. And yet we still have some growth. If we hadn't had the European crisis, 2011 would have been a much better year."

This led Koo to be reasonably optimistic for the year ahead.

"I anticipate continued growth for 2012. I don't have a number. I am not qualified to make predictions. But I'm optimistic. I think we'll see growth, probably not like in 2009 and 2010, but we'll be able to manage," he said.

Sean Gordon, head of third-party distribution, Investor Solutions at Barclays Capital, agreed that 2011 versus 2010 was not a fair comparison.

"Growth was very strong in 2009 and 2010 in the context of a recovery after the 2008 financial crisis," he said.

"Just after the collapse of Lehman, structured products issuance dried up for three to six months, but it came back strongly in 2009 because once the market healed, people looked for alternative ways to achieve yield."

Euro concerns

Europe is the main risk in the market, and a lot of next year's activity will depend on how the crisis is managed and if it gets resolved, sources said. In the meantime, predictions come with many "ifs."

"If factors stay the same, if GDP is positive, if the unemployment level doesn't increase and actually slowly improves, then I feel that the market will increase in volume between 7% and 14% next year," said Andrew Valentine Pool, head trader at Regatta Research & Money Management.

"Issuance volume in the U.S. next year will depend on the unfolding events in Europe," Gordon said. "If conditions worsen and become reminiscent of what we saw during the Lehman crisis, there will be a decline in volume. Putting aside this worse-case scenario however, we see an average growth rate of 10% for next year."

Adjusting to demand

Investor sentiment will also play an important role, sources said.

How fast investors adjust to market conditions will be relevant, according to Pool. If investors can see that structured products offer value, then growth may be the outcome.

For instance, if the market trades sideways, investors may find it beneficial to use leveraged enhanced growth products.

Because each client needs to find a specific solution, educating advisers will also be a factor driving growth, he noted.

"Volume also depends on the types of investors," said Ian Merrill, head of product origination, Americas in Investor Solutions at Barclays Capital.

"This year, with private bank clients, you saw more targeted deals. Clients purchased deals in an effort to look for access to certain asset classes. They bought Asian equity baskets or some specific capped notes as well as commodities-linked notes.

"The overall market on the other hand was following a different theme, buying around the concept of yield. Where can I find it while reducing my exposure to the downside?"

Issuers also need to adjust to quickly changing market conditions in order to provide investors with the solutions they're looking for at the right time, according to Serge Troyanovksy, head of retail distribution, North America for structured products at BNP Paribas.

"One of the biggest challenges for the industry is to continue to bring out products that fit investors' market outlook and add value to their portfolios. In certain market conditions, such as a low interest-rate environment, investors may simply be looking for a pick-up in yield. In a volatile market, they may be seeking downside protection. After a decline in the markets, investors may want to cautiously re-enter the markets. When an outlook is more optimistic, investors may want to have a leveraged participation on the upside."

Ultimately, macroeconomic factors and headlines will dictate the big picture for next year in terms of demand, preferred structures and appetite for risk.

"The two biggest factors likely to drive volume next year are Europe and the U.S. presidential elections," said Gordon.

"For Europe, the wildcard is whether the crisis will be resolved, as they can't stay with the status quo forever. For the U.S., the elections will drive headlines until they come to a close in November. However, if these issues are addressed, uncertainty will subside and volatility should come down. This in turn would help increase volumes by bringing more investors back into the market once they see it stabilize.

"Investors in general are more comfortable when volatility is lower. Higher volatility is better suited for short-term traders. As such, high volatility makes the general public more fearful, eventually leading them to stay on the sidelines."

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