Buoyed investors re-enter structured products market, increase sales by 37% from December

By Emma Trincal

New York, Jan. 23 - With the bull market in full swing since the start of the year, investors are less shy about bidding on structured products, source said, which has boosted volume so far this year. However, for those sources, it is still too soon to draw conclusions.

"I'm guardedly optimistic," a market participant said.

"We'll see a lot of growth compared to the end of last year. But the year is just beginning, and there's a long way ahead of us."

Agents in the week ended Friday sold $397 million in 98 deals, a decrease from the prior week, which saw the pricing of 97 deals for $485 million, according to data compiled by Prospect News.

However, figures for the year and month to date are encouraging.

In the Jan. 1 through Jan. 19 period, sales have reached $1.46 billion, a nearly 20% increase from the same period last year, which recorded $1.21 billion. The number of offerings slightly decreased to 252 from 276 last year. This reflects a greater number of larger deals, with 19 deals above $20 million so far this year versus 13 last year.

For the month to date, sales have increased by nearly 37% from $1.07 billion priced in Dec. 1 through Dec. 19 of last year. The number of offerings shrunk in January from 326 in the same period last month. January has seen so far a greater number of larger offerings: four products priced in excess of $50 million so far this month, compared with only one last month.

Since the fiscal cliff deal, investors have pushed up equity prices. As of Wednesday, the S&P 500 index has gained more than 2% since the beginning of the year, leading market participants to conclude that investors are focusing on the good news, such as earnings, instead of the upcoming headwinds such as the debt ceiling debate.

Rally mood

"We're seeing increased interest from the marketplace with the bull market. We also see stronger earnings results in January," the market participant said.

"It can be the general lift in the market that helps sales of structured notes.

"Often, when there is a short pop, we see clients who missed the uptrend wanting to get in with some downside protection to make up for what they missed in the initial pop."

Some sources are cautious about issuance volume trends.

"It's just the market in general, to be honest with you. Folks are just putting some money to work, structured products being one avenue in particular," said a sellsider.

"Earnings have done quite well. But it may be early in the year. The larger volume may just have to do with one or two larger deals, like the Morgan Stanley."

Morgan Stanley priced the top offering last week, $110 million of 0% contingent income autocallable step-up securities due Jan. 18, 2028 linked to the S&P 500 index. Investors received a contingent monthly coupon if the index closed at or above a 70% barrier on a monthly determination date. If not, they received no payment that month.

The contingent coupon stepped up from 7% per year initially to 8% on the fifth year and to 12% on the 10th year.

After five years, the notes were autocallable if the index closed at or above the initial price on any quarterly redemption determination date.

If the notes were not called, investors would receive par plus their final coupon if the index at maturity closed above a final barrier of 50% of the initial index level and would be fully exposed to losses otherwise.

Sources saw in the success of the deal a sign that the search for yield remains a dominant market trend.

"We still see a lot of demand for income products along with additional innovation in these products as manufacturers better understand what clients are interested in as well as what their risk sensitivities are," the market participant said.

"The Morgan Stanley [deal] is representative of this, as it provides some new features or combinations of features such as steps, income contingency and a low barrier," he noted.

"We're getting increasingly positive news in the economy. As long as it continues, we'll see interest from investors not just in the market but in structured products as well."

While cautious, the sellsider agreed.

"My guess is that it will be a good year," he said.

Equity up

The volume of equity-linked notes last week was up nearly 20% at $360 million, or 91% of the total, in a sign that investors have regained confidence in the market.

The growth mostly originated from equity indexes, up 30% from the prior week at $184 million, or 46.5% of the total. In comparison, the market share for single stocks declined last week by 53% to $74 million, or less than 19% of the total.

"The bid for equity products is stronger, but it's mostly with indices," the sellsider said. "There is less interest in selling volatility on single names."

The CBOE Volatility index, or VIX, has collapsed from 18 on Dec. 31 to 12 on Wednesday, hitting new record lows. Many stock-linked notes sell volatility in order to offer attractive coupons. When volatility is low, the pricing of those deals, for instance reverse convertibles, becomes more challenging, he said.

As a sign of buoyed investor confidence - some sources said "complacency" - the fear gauge has dropped almost by half from 22.72 in December prior to the fiscal cliff resolution to 12.32 on Wednesday. The equity market in the meantime is at a five-year high.

The third largest deal last week was based on a single stock. It was Goldman Sachs Group, Inc.'s $25 million of 8% equity-linked notes due Jan. 15, 2014 linked to the common stock of Qualcomm Inc., an increasingly popular technology stock. It has been used relatively moderately - 10 times since the beginning of last year, according to the data.

One type of equity underlying, baskets of stocks, made for more than a quarter of the total volume sold last week, with $102 million done in three deals. The unusually large size for this asset class was due to the second largest offering of the week, an issue sold by BMO Capital Markets Corp. on the behalf of its parent company, Bank of Montreal.

In a follow-up of its $100 million deal in December, Bank of Montreal priced $100 million of 0% senior medium-term notes, series B, due Dec. 23, 2013 linked to Raymond James Analysts' Best Picks for 2013. As with the prior issue, the underlying stocks were AmerisourceBergen Corp., Altera Corp., Bed Bath & Beyond Inc., Ctrip.com International, Ltd., Equinix, Inc., Jabil Circuit, Inc., Nuance Communications, Inc., Protective Life Corp., Trinity Industries, Inc., Tractor Supply Co. and Zions Bancorp, equally weighted, and the notes priced at 102.75.

Exchange-traded funds as an underlying asset class were not in favor last week. They were down 61.5% for the week and 21.5% for the month, the data showed. Currency and commodity notes were also on the decline.

Contingent coupons

The leading structure type so far this years as well as last week are callable reverse convertibles. Those products offer a contingent coupon based on a barrier observable periodically with an autocallable feature and a final barrier. Typically, the call and the contingent coupon are triggered when the underlying is above the initial price on an observation date, and the contingent coupon alone is triggered when it is above the barrier but below the initial price. At maturity, the barrier will determine if investors lose principal or not.

Those deals make for 21% of the year-to-date total and have increased 4.5 times from the same period last year, according to the data. They represented nearly 40% of the total last week, although this result is skewed by the size of the Morgan Stanley offering, which fit into this category.

Simple trackers, or delta one notes, were the second most popular structure last week with 29% of the total. The top product in this group was Bank of Montreal's notes linked to the Raymond James research basket.

Leveraged deals with no barriers or buffers remained the No. 1 structure for the month with $391 million, or 27% of the total, but they declined last week to $32 million from $138 million the week before.

Morgan Stanley was the top agent with $128 million priced in four deals, or nearly a third of the total volume for the week. It was followed by BMO Capital Markets, which priced the deal tied to the Raymond James stock picks - the week's second largest offering - giving this agent a 23% market share. JPMorgan was third with nearly 11% of the volume.

"I'm guardedly optimistic." - A market participant

"It's just the market in general, to be honest with you." - A sellsider

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