Issuance slows to $234 million, down 83%; market records lowest weekly volume since December

By Emma Trincal

New York, June 9 - U.S. structured products agents only issued $234 million in 59 deals last week, the slowest week on record this year and one that sharply contrasted with $1.39 billion sold in 301 deals the week before.

While it's fairly normal for issuance to be weak during the first week of any month, the 83% decrease from one week to the next was significant, sources said.

"We had a lot of volume until end of April. But May was a catastrophe," a sellsider said.

"Distributors are having a hard time telling skittish investors to enter the market now."

When volatility is on the rise, issuers are able to price their deals in a more cost-efficient way, giving investors the most attractive terms, sources noted. And yet, this pattern was not reflected in last week's data.

"Volatility is high. Now should be the best time to enter the market. But fear prevails," the sellsider said.

The week ended Friday was a short four-day week due to the Memorial Day holiday.

But the post-holiday factor may not be sufficient to explain why volume was so low compared to all other weeks of the year.

Slowest week of 2010

Data compiled by Prospect News shows that the week's volume was at least twice as weak as it has been during the first week of any month of this year.

One has to go back to the week between Christmas and New Year's Day to find a weaker volume of $152 million, according to data compiled by Prospect News.

When comparing last week's numbers with the first week of each month this year, February recorded the second-lowest first-week volume with $467 million in 70 deals. It was followed by the first week of May with $476 million in 73 deals.

The first week of January posted $1.66 billion. And both the first weeks of March and April hit the half-a-billion dollar mark.

Back to work

The impact of a holiday weekend on business appears to have grown in importance, suggested Brad Livingston, a distributor at Laidlaw & Co.'s Income Solutions Group.

"It now takes a few days to recover from a holiday. After a day off, it could take a full week before people can get to work. I would expect this week to be better," said Livingston.

"Then of course you have school breaks and the start of summer holidays," he noted.

Volatility freeze

But the rise of volatility is also keeping investors on the sidelines, sources said.

"Investors are concerned about volatility. With strong electronic trading, you can get a lot of people out of the market quickly. Advisers are accumulating cash at a pretty big clip," said Livingston.

"But if volatility continues to rise, volume will rise too because people will be looking at structured products for principal protection."

The state of global markets is cause for concern as well.

"People remain worried about European debt, and now fears are brewing around Hungary and Austria," the sellsider said.

"It's not so much institutional but retail clients who are pulling back. Uncertainty is weighing on retail. Retail clients are always last to get on board. But institutions continue to invest. I think the slowdown in volume will be a trend that will persist until the end of the summer," he added.

Dwarf deals

The size of the top deals last week also reflected the deflated issuance.

The two top offerings - at $24.32 million and $16.31 million - paled in comparison to the $110 million and $101 million leading deals of the prior week, according to data compiled by Prospect News.

There were only eight deals in the $10 million or more size last week versus 35 the week before.

The average deal size shrank by 14% to $3.96 million from $4.61 million.

Flight to the U.S.

Investors had a strong preference for U.S. equity indexes-linked notes even though the top deal - Goldman Sachs Group, Inc.'s $24.32 million of leveraged buffered index-linked notes linked to the MSCI All Country World index - contradicted the trend.

"It's a function of what people would buy. A lot of products are still sold through brokerage channels. Brokers present S&P products to clients who are not familiar with structured products. You have to use a familiar index for first-time investors. When you introduce a concept, you have to do it with something people know," said Livingston.

Others said that the trend reflects an aversion for Europe but that, by the same token, investors are missing on other global opportunities, notably in the emerging markets.

"The dollar is up and people are finding shelter in the U.S.," the sellsider said.

"We know why Europe is down. It's not clear why money wouldn't go more into emerging markets. Retail clients don't know about global equity. They could invest in Asia or Eastern Europe. For retail investors, emerging markets is basically Brazil," he added.

Out of the 59 deals that priced last week, 34 were linked to either U.S. equity indexes or U.S. stocks. Two of the top three deals were linked to the S&P 500 index.

Morgan Stanley priced $16.31 million of 0% knock-out notes due Dec. 12, 2011 linked to the S&P 500, the second-largest offering. It was followed by Goldman Sachs pricing $16 million of floating-rate notes due July 18, 2011 based on the S&P Diversified Trends Indicator Total Return Modified. The coupon was set as Libor minus 50 basis points, payable quarterly.

50% in stock indexes

Within equity, another trend was investors' strong preference for equity indexes versus single stocks. Equity indexes-linked notes represented half of the total issuance versus 40% the week before. Nearly 30% of all deals were linked to equity indexes versus 17% in the last week of May.

Going hand in hand with the reduced interest in single stocks was the decreased volume of reverse convertible sales. There were only 22 such deals last week totaling $22 million, or 9% of the issued volume versus 14% of the prior week's total issuance.

"It's not easy for issuers to do stock-picking right now. They'd rather rely on broad indexes," said the sellsider.

Leverage is neutral

Appetite for leverage, already observed during the prior week, continued to be an important development.

Two-thirds of last week's volume came from leveraged notes with or without protection, versus 43% the week before, according to data compiled by Prospect News.

Sources said that they expected the trend, which has been seen over the past few weeks, to carry on.

"Leverage will remain a trend," said Livingston. "Every time people are moderately bullish or bearish, leverage is going to look very attractive. Among investors I talk to, very few say that the market is going to go up double-digits. When the market is neutral or flat, leverage will sell like hot cakes."

Another reason, Livingston continued, is that investors two years ago became familiar with structured products as they sought to invest in principal-protected products.

"A lot of portfolios are stuck up with principal-protected products. If you're comfortable with structured products and you've been buying them for a couple of years, the next step is moving from CDs to leveraged notes," Livingston said.

"Investors realize that structured products are going to do what they say they're going to do. We're not going to have another Lehman. Investors are more open because they're now used to structured products," he added.

"It may not be ideal to use leverage in this market, but people are chasing returns," the sellsider said.

Commodities, broadly

As before, other asset classes continued to be less widespread.

Commodities deals, which had progressed in percentage of the total during the week before, remained flat at 17% of the volume last week.

Compared to the prior week, when reverse convertible formats where used to gain access to commodities, issuers put more emphasis on structuring products around broad commodity indexes than on single stocks.

Only three interest rates deals priced last week for $6 million in total, all brought to market by Barclays.

This asset class declined to 2.5% of total issuance from 6% the week before.

Currency exit

Currencies were definitely out with only one deal priced by Morgan Stanley. Sized less than half a million, the notes offered a bearish bet on the euro against a basket of currencies.

So far, sources have explained the sustained decline in currency-linked notes issuance as a structural pattern. With demand spiking for bearish bets on the euro zone currency, options costs have surged as well, rendering those deals difficult to price for issuers. Currency experts so far have assumed that demand was there for those products but that supply was not able to match it.

But some market observers disagreed.

"I don't know if it's driven by supply rather than demand," the sellsider said.

"There's little demand for currencies because clients don't understand non-U.S. markets. There are many bets to make on European or Asian currencies.

"It's a pity that we don't see more currency notes. People should play emerging markets via currencies instead of doing it with equity baskets. It's a lost opportunity."

Without commenting on currencies specifically, Livingston noted that the market sometimes shows a disconnect between supply and demand.

"Things distributors or issuers think are good issues aren't always things that clients think are good," he said.

"We should always remember that we're trying to satisfy the needs our clients have."

Goldman Tops

Goldman Sachs led the week with $80 million sold in 10 deals for 34% of the market.

JPMorgan came second with $56 million in 18 deals for 24% of the total volume.

The third agent was Morgan Stanley selling 11% of the volume for $27 million in four deals.

Merrill Lynch, which took the fourth slot, had the largest deals in size with $10 million on average, followed by Goldman Sachs ($8 million) and Citigroup ($7.5 million).

Barclays was only ranked No. 7 with less than 5% of the total even though this agent is No. 1 in the year to date with 40% of the market share.

"It now takes a few days to recover from a holiday." - Brad Livingston, a distributor at Laidlaw & Co.'s Income Solutions Group

"Volatility is high. Now should be the best time to enter the market. But fear prevails." - A sellsider

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