Structured notes volume jumps after holiday slump, but summer is said to be the worst ever

By Emma Trincal

New York, July 18 - The U.S. structured notes market went back to work last week after the Fourth of July pause, according to data compiled by Prospect News.

Yet the pick-up was not enough to improve the long-term picture, which points to a slowdown so far this year and also for July.

Equity index-linked notes surged last week as well as leveraged notes with partial protection, offered through either a buffer or a barrier, the data showed.

Agents sold $344 million in 74 deals last week, a 216% increase in volume from the short and exceptionally poor prior week, which recorded only $109 million in sales. These numbers do not include exchange-traded notes.

But a lag in sales continued to be noticeable over a broader timeframe.

Volume plummeted by 41.61% from July 1 to July 14 compared to the same time in June.

The same percentage of decline (negative 41.76%) also applied to the month-to-date volume compared to the same month a year ago, according to the data.

Summer blues

For the year, sales so far amount to $19.9 billion, an 18% decline from the $24.27 billion that priced during the same period of time last year.

"Everybody is asleep. Issuance is on hold," a sellsider said.

"It's the summer. It's dead. It's really one of the worst summers I've ever seen, if not the worst."

To this sellsider, macroeconomic and political factors are the culprit.

"Europe is a mess. There is no clear vision of what's next in the U.S. I'm not optimistic about September," he said.

The gloom and doom felt by some sellsiders is not necessarily shared by everyone, a market participant said.

"It varies from each individual desk on what they do and what they have in the pipeline," he said.

But he admitted that the market does not help.

"There is still a lot of uncertainty. When there is uncertainty in the market, people are less likely to trade. It's a neutral market. It makes it hard for people to express a view," he said.

Tough to price

Perhaps the main problem observed by market participants is that products do not meet investors' expectations.

Many sources agree that the lower volume this year is a result of two factors: a difficult - some say "impossible" - pricing environment and investors' natural reluctance to commit capital to dull products.

"When you have interest rates as low as they are, it's very difficult, almost impossible, to structure anything that's compelling," a market insider said.

"The interest is there from the public. But the good products are not. To do anything compelling you have to extend maturities, because there's no other choice. That kind of market curtails the investment base. Many investors don't want to go that long in duration. They put themselves in one- to three-month CDs instead," he said.

This source added that the belly of the yield curve has been flattening significantly.

"It's been a continuous trend. Now the market is used to these levels. Volatility is low in equities and it's low on a relative basis in rates. The result is you have to go long term, and most people are opting to stay liquid," he said.

"The breadth of products has shrunk, and the economics of the deals are not so great anymore."

Bid on buffers

Leveraged products with partial downside protection are on the rise, a trend that may reflect investors' uncertainties about the market, the market participant said.

Last week, these types of products surged by 5.5 times to $177 million from $32 million. The category represented 52% of the total, a record level for that structure, which despite its popularity does not usually garner so large a market share.

The same pattern is also true for the month: volume grew by 217%, and the structure accounted for 46% of the total.

For the year to date, leveraged notes with partial protection rose by 19.5% and represented 20% of the volume.

The market participant explained that choosing this structure is a compromise between fully protected notes that have become invisible and pure leverage with no protection.

"Instead of buying an ETF, you have the opportunity to alter the payout by either leveraging up the upside or giving up a little bit of it for protection," the market participant said.

"Full principal protection is very difficult to price.

"When you choose some partial protection, it gives you a higher probability of success. It's still not easy to come up with a buffer given the low volatility. But volatility is only a component of pricing. You're also taking future dividend flows that you can use for optionality."

Index enthusiasm

Notes linked to equity indexes made a strong push last week, increasing by more than four times in volume to $280 million from $63 million the week before. This asset class contributed to a record market share of 81% of the weekly sales. Equity itself, as an asset class, reached new highs, making for 95.4% of the total last week.

Equity indexes are one of the few asset classes to have grown on a year-to-date basis. They are up 30% from last year, and the asset class accounts for 55% of the total this year versus 35% last year.

It's difficult to predict whether index-linked products will continue to dwarf stock-linked notes this year.

"It's really hard to interpret why people sometimes prefer stocks and why they favor indexes some other times. I think it varies," the market participant.

Top offerings

Goldman Sachs topped the league tables last week. It sold 44.57% of the total volume with $153 million in five deals. It priced the No. 1 and No. 3 deals, both leveraged buffered notes.

Goldman Sachs Group, Inc. priced $70 million of 0% leveraged buffered index-linked notes due July 24, 2017 linked to the S&P 500 index. The payout at maturity will be par plus 1.5 times any index gain. Investors will receive par if the index falls by up to 50% and will lose 2% for each 1% decline beyond 50%.

UBS AG, London Branch priced the second largest deal with its $68.56 million of 0% capped index knock-out notes due July 31, 2013 linked to the S&P 500.

The 80% knock-out level is observable any day. In the absence of a knock-out, the payout at maturity will be par plus the index return, subject to a minimum return of 8.65%. Investors have full exposure to losses in the event of a knock-out. In each case, the return is capped at 15%.

Goldman Sachs priced the third offering with $60.61 million of 0% leveraged buffered index-linked notes due Jan. 14, 2016 linked to the S&P 500. The upside leverage factor is only 1.04, but investors enjoy a 35% buffer on the downside.

After Goldman Sachs, UBS was the No. 2 agent last week. It sold 48 deals totaling $122 million, or 35.6% of the total.

"It's really one of the worst summers I've ever seen, if not the worst." - A sellsider

"It's really hard to interpret why people sometimes prefer stocks and why they favor indexes some other times." - A market participant

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