Volume explodes by 233% to $1.59 billion for week, but May remains weak

By Emma Trincal

New York, June 1 - Volume surged 233% during the pre-holiday week ended Friday, but May saw a decline in sales compared to April, according to data compiled by Prospect News.

Last week, 223 non-exchange-traded notes deals priced totaling $1.59 billion versus $479 million the week before, making last week the U.S. structured products market's best week for the month. While strong activity is always expected at month-end, no deals priced on Friday, according to preliminary data, which makes the result all the more significant, sources said.

The strength of issuance was also evident in the number of big deals: 52 offerings of more than $10 million last week against only 13 the week before. Agents priced five transactions exceeding $50 million in size, while none came to market during the prior week.

Poor May

On a month-to-month basis, though, May was disappointing. Excluding ETNs, agents priced $2.82 billion in 490 deals last month, down nearly 6% from the $2.99 billion issued in April in 478 deals. Even though the decline was subdued, May appears to be the weakest month so far this year in volume.

Sales of all structured products including ETNs amounted to $3.43 billion in May. This is way below January, the top month, which saw the pricing of $8.47 billion, and even less than February, previously the weakest month with $4.54 billion.

"They say 'sell in May and go away.' There is truth in this," a structurer said.

"Many people are already positioned, and there's not much new money coming in. People are looking at what's going to happen next."

This structurer said that the European debt crisis, the war in Libya and the weakening dollar are keeping investors away from the market.

"Everybody is wondering what's next after QE2. Rather than spending much time and money in the market, people are staying on the sidelines," he said.

QE2 is the quantitative easing program implemented by the Federal Reserve Board. Designed as an easing monetary tool through the Fed's purchase of Treasuries, the policy is expected to end at the end of the month.

"Volatility has been choppy in the last two months. It hasn't gone anywhere. A lot of that has contributed to the slowdown in structured products issuance," a sellsider said.

Stocks versus indexes

Equity as an asset class returned to normal levels, accounting for 70% of the issuance, versus 53% the week before. Single-stock underliers and equity indexes were even as a percentage of the total at 33% and 34%, respectively.

However, the trend for the month has been a renewed interest in stocks and a decline in equity index deals, according to data compiled by Prospect News.

Stock-linked notes rose by 8.5% to $976 million in May compared to April, while equity index products fell by more than 15% to $850 million.

Some sources have invoked volatility levels as an explanation. Stocks are offering more volatility and hence potentially higher returns.

But the structurer said that there is no correlation between volatility levels and investors' preference for stocks or indexes.

"When volatility is high, index volatility spikes also. And with the heavy index hedging by institutions, index volatility can be as high as single stock volatility," he said.

"If volatility falls, for instance, index volatility will crash as fast."

Commodity exposure

Another explanation for the growth in stock deals, sources said, is the rising interest in commodity stocks as a way to gain exposure to this asset class.

The top deal of the week, for instance, was a reverse convertible linked to an oil stock.

Citigroup Funding Inc. priced $87.63 million of 7.5% Equity LinKed Securities due Nov. 23, 2011 linked to Schlumberger NV shares. The payout at maturity will be par in cash unless Schlumberger shares fall below the protection price, 80% of the initial share price, during the life of the notes and finish below the initial price, in which case the payout will be 0.12008 shares of Schlumberger stock.

Pure commodity deals grew in dollar amount - up 64% to $254 million - but declined as a share of the total to 16% from 32% the week before.

However, the top three deals after Citigroup's Schlumberger were all commodity-linked notes.

Eksportfinans ASA priced $64.32 million of 0% Accelerated Return Notes due July 31, 2012 linked to the Rogers International Commodity Index - Agriculture Excess Return via Bank of America Merrill Lynch. The payout at maturity will be par of $10 plus triple any gain in the index, subject to a maximum return of 18.6%. Investors are fully exposed to any index decline.

Bank of America Corp. priced $60.87 million of 0% Accelerated Return Notes due Nov. 19, 2012 linked to the Brent crude oil futures contract. The payout at maturity will be par of $10 plus double any gain in the price of Brent crude oil futures, up to a maximum return of 44%. Investors are exposed to any losses.

AB Svensk Exportkredit priced $50.77 million of 0% Accelerated Return Notes due July 27, 2012 linked to the PHLX Oil Service Sector index via Bank of America Merrill Lynch. The payout at maturity will be par of $10 plus triple any gain in the index, subject to a maximum return of 23.61%. Investors are also fully exposed to any index decline.

"Investors looking to get exposure to commodities tend to prefer stocks as a way to get rid of the contango problem," the structurer said.

"It's also easier to use a stock than a future contract. People don't want to be delivered 200 pounds of wheat into their houses."

Rates

Interest rates deals made a comeback last week but retreated on a monthly basis.

Agents sold $111 million of rate-linked notes last week, compared with $7 million the week before. But only $182 million priced in May, down nearly 40% from April when agents sold $298 million of those products.

"The market has rallied every day since mid-April. It has killed the rates business. Step-ups, rates-linked products have been hard to put up," the sellsider said.

Rates deals are often bets on a steeper yield curve. For instance, the top offering in this asset class last week was Bank of America's $29.5 million of callable capped notes due May 27, 2031 linked to the 30-year and two-year Constant Maturity Swap rates.

The coupon is 12% for the first year. After that, the rate will be four times the spread of the 30-year CMS rate over the two-year CMS rate minus a strike of 25 basis points, up to a maximum of 12%. Interest is payable quarterly and cannot be less than zero. The payout at maturity will be par, but the notes are callable after one year.

Some market participants do not see value in those deals.

"People continue to make bets on a steepening of the yield curve. I think they're wrong," the structurer said. "The curve is already very steep. If we get higher rates, the curve will flatten. The long end of the curve will not rise as fast."

Buffers out

With volatility continuing to decline - the CBOE Volatility index, or VIX, was down 12.5% last week to 15.98 - the favorite structure continued to be leverage with no protection.

The cost of leverage is cheaper when volatility falls, sources said.

Leveraged deals with no buffers represented 28% of the market last week at $448 million, up in market share from 14% the week before. This structure was also the most popular on a monthly basis, with more than 20% of the total for May.

"We are seeing the trend. Buffers are really expensive. It makes sense to drop the buffer if you're bullish on the underlying. We'll see more and more of that," the structurer said.

"Going from 10% to a 15% buffer is an expensive option. From zero to 10%, it's a hugely expensive option. The more sophisticated investors are not willing to pay that buffer."

The second, third and fourth largest offerings were all based on a leveraged structure with no buffer.

Reverse convertible exploded as it is almost always the case at the end of each month. Agents sold $357 million of them in 108 deals, up 382% from the previous week. Reverse convertibles last week amounted to 22% of the total, versus 15% the week before.

Sales of reverse convertible rose by 28.5% in May to $568 million from $442 million in April.

Barclays was the top agent for non-ETN deals with $606 million in 25 deals, or 38% of the total.

UBS was second, pricing $187 million in 26 deals for an 11.75% market share.

The third agent was Merrill Lynch, which brought to market five deals totaling $161 million, or 10% of the volume.

The top agent the week before was JPMorgan, followed by UBS and Morgan Stanley.

"They say 'sell in May and go away.' There is truth in this." - A structurer

"The market has rallied every day since mid-April. It has killed the rates business." - A sellsider

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