February slows compared to January, but sources note month is not over; year's volume is up 11%

By Emma Trincal

New York, Feb. 20 - February's volume is showing signs of weakening, at least in its first half. But sources said that it is too soon to tell, pointing instead to the yearly advance. Issuance is up nearly 11% year to date, according to data compiled by Prospect News.

Agents sold $142 million in the week ended Feb. 16, a 68% decline from $439 million sold during the prior week, the data showed.

From Feb. 1 to Feb. 16, sales amounted to $738 million, compared with $1.4 billion during the same period in January, a 47.5% decline. Sources attributed this result to an exceptionally good month of January. They also cautioned that the data only covers the first half of February, not the second, usually the most active part in the calendar.

The comparison to a year ago also disappointed. Sales in the first half of February were down 24% from Feb. 1 to Feb. 16 of last year, when volume was $974 million.

Part of the explanation, according to the data, is January itself.

Last month's volume surpassed January 2012 by nearly 23%, with $3.56 billion sold last month in 656 deals versus $2.90 billion priced in January 2012 in 645 deals.

Last month had some of the best weeks on record in more than a year. For instance, $1.12 billion priced during the week of Jan. 20, and the week of Jan. 13 saw the pricing of $720 million, according to Prospect News data.

February versus January

"I'm not going to look at short-term data. February is not over yet. The fact that we are up 11% from January 1 to February 16 is a good indication that we have a good start of the year. It's encouraging," a sellsider said.

However, he conceded that February so far looked a little soft.

"We had a very good January and since then, it seems to be slowing down. But February is always challenging because of the uncertainty that follows the bonuses paid in January," he added.

"Some people may leave the banks if they're not happy. People leave in February. You have shortages on the desk and fewer people are there to sell the product.

"I heard of a couple of banks which are very active in structured products that have had layoffs recently. It doesn't help morale.

"It's ironic that people may be leaving now as the market is getting better. You would think that banks would need more people now, but instead that's when they're leaving because there's always a lag.

"On the other hand, it's half of the month; we can't really say that February is slow. It's too soon to tell. Let's see what the other half of the month will bring."

February may just not have been able to match the remarkable activity seen last month, a market participant said.

"February usually is a good month. It's hard to judge right now," this market participant said.

"It could be that people have put on more trades in January, and since the pool of investors is the same, they may have pulled off in February. ... The appetite may have been at it a bit more subdued this month."

A negative factor that played out last year may still be in place, which would explain the deceleration seen so far this month in terms of volume, the sellsider said.

"I see the biggest hurdle coming from regulators," he said.

"Firms cannot figure out what Finra is expecting of them. They just don't understand what the appropriate procedure should be in terms of complex products. There's such a lack of clear guidance on the part of the regulators that everybody just stopped. Of course, you wouldn't have that problem with simple CDs, but CDs don't work anymore because of pricing."

Rally

One positive factor capable of supporting a robust volume of sales is the market itself, sources noted.

The Dow Jones industrial average gained 5.5% as of Feb. 16 since the year began, and most equity indexes have reached new highs.

This has led investors to flock into equity-linked products, which include stock, equity index and equity exchange-traded funds underliers.

Last week for instance, 93% of the issuance volume was linked to equity assets, compared with 79% during the previous week.

Stocks made for 16% of the total and equity indexes, 77%. The S&P 500 index, the Russell 2000 index, the Euro Stoxx 50 index, the iShares MSCI Emerging Markets ETF and the MSCI EAFE index were among the most popular equity underlyings.

Exit from bonds

"The equity markets are doing well. The S&P is at an all-time high. It's understandable that people would be focusing on equity," the sellsider said.

Part of the bid on equities came from a reallocation from bonds to equity, he said.

"People who have been chasing yield have been invested in bonds for a while. A lot of investors are already heavy in bonds. But now, in order to get more yield in bonds, you have to go longer in duration, and that's quite risky," the sellsider said.

"It makes sense for people to start looking at equity. Naturally, structured products are following suit. People are looking for structured products to express their views on equity."

For the market participant, the equity rally was a positive trend for structured products issuance as investors tend to be more attracted to passive investing when correlation between asset classes increases.

"When you have a highly correlated market, whether during a rally or during a sell-off, it's hard to find alpha and the value of stock-picking tends to recede. That's when people gravitate around passive investing and indexing," the market participant said.

"Generally speaking, structured notes are linked to index-based products. Structured products are great in those markets as they allow you to express a view on the index while changing the payoff as opposed to a direct investment in the underlying.

"Exchange-traded products are the major story of passive investing, and structured notes are the products of that story."

Changing the payoff

The ability to modify the risk/return profile of an asset in the midst of a rally was one of the driving forces behind the robust issuance pace seen so far this year, the sellsider said.

Stocks in all sectors have rallied aggressively, leaving some investors sometimes cautious about valuations and wondering about how long the rally is going to hold up.

"People are worried about prices. Is the market overheating? Does the rally still have legs? If you need an entry point, structured products are the right area to go. You do see the market doing well. If you're not in the market, you've been missing the party. Instead of going long equity directly, you can consider a structured product. It gives you a little bit of protection with a buffer, an accelerated return with the leverage. It makes sense if you worry about your timing," the sellsider said.

"If the regulators were not confusing the market, you would see a lot more sales because structured notes are in demand."

Top structures

Leverage with or without partial downside protection remained the most favored structure both last week and also for the year to date.

About a quarter of this year's total volume - or $1 billion - comes from leveraged notes without any downside protection, or more than double the amount of products issued in this category last year.

Leverage with buffers or barriers represented 17% of the total for the year at $752 million, a slight decrease of 2.3% from last year.

The second top structure of the year falls into the category of autocallable reverse convertibles, with $752 million sold, or 17.5% of the total, a 174% increase from last year.

"If you put these three categories of products together - leverage without protection, leverage with partial protection and autocallable reverse convertibles - it's pretty much all the same: these are principal-at-risk products," the sellsider said.

"Sometimes people want a higher cap without the buffer; sometimes it's the other way around."

Last week, 42% of the market consisted of leveraged notes with barriers or buffers.

"The structures limit your upside with a cap or a call premium, and on the downside, 100% of your principal is at risk. That's the nature of the investment.

"Principal at risk and limited appreciation, that's what's playing on in the market," he said.

The common denominator of these products, he said, was the search for yield even with leveraged products that offer upside participation in the underlying given that there is almost always a cap.

"Investors are yield-driven. They're not looking for unlimited growth. Because of the market conditions, you're not getting full principal protection, you may just get some partial protection in the form of a buffer or even nothing," the sellsider said.

"That's what people are looking for: not CDs but principal-at-risk products.

"The view expressed by the investors is moderate: you think the markets will be higher but not that much higher. It may even go down a little bit. But you don't think it's going to go down a lot. These are mildly bullish products.

"Every time you want leverage it's because you believe the market will go up a little bit but not a whole lot. You're not optimistic that the market itself will go up as much as you would like it to be. If this is your view, buying the market doesn't help you. But a structured product may be the solution," he said.

For the market participant, leverage has always been "the best-selling structure." But current market conditions may render these products even more attractive than usual.

"People are bullish. They tend to [move] away from bonds into equity. Investors that have been missing on the equity rally want to use leverage," the market participant said.

Top agents, deals

Barclays was the top agent with $27 million sold in 11 deals, or 19% of the total.

It was followed by JPMorgan and Morgan Stanley.

Barclays was the agent for the top deal last week: Credit Suisse AG, Nassau Branch's $21.73 million of 0% accelerated return notes due Aug. 17, 2016 linked to the S&P 500.

The payout at maturity was par plus 1.3 times any index gain. Investors would receive par if the index fell by up to 30% and would be fully exposed to any losses if the index finished below the knock-in level.

Morgan Stanley priced the second largest deal of the week, $12.59 million of 0% market plus notes due Aug. 15, 2014 linked to the S&P 500.

A knock-out event occurred if the index closed below the knock-out level, 82.25% of the initial level, on the final valuation date.

If a knock-out event had not occurred, the payout at maturity would be par plus the greater of the index return and zero. Otherwise, the payout would be par plus the index return, with full exposure to losses.

Morgan Stanley & Co. LLC was the agent with J.P. Morgan Securities LLC as dealer.

"February is always challenging because of the uncertainty that follows the bonuses paid in January." - A sellsider

"Investors that have been missing on the equity rally want to use leverage." - 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.