Month ends with bonanza week, but general picture still bleak as risk aversion makes comeback

By Emma Trincal

New York, Aug. 1 - Volume more than doubled last week compared to the week before, but issuance continued to dry up on a month-to-date and year-to-date basis, according to data compiled by Prospect News.

Investors flocked to conservative bets - in particular, structures linked to the S&P 500 index as well as leveraged buffered notes - in an effort to deal with the increasing uncertainty seen in the equity markets, sources said.

"As people get more concerned about risk, they go back to blue chips," a sellsider said.

Forty four deals last week were linked to the S&P 50, out of 253 in total, including the two largest offerings. Bank of America Merrill Lynch sold the top nine S&P 500-linked notes, all of which exceeded $20 million in size.

Agents sold $963 million of structured notes in the week ended July 28, an 182% increase from the $342 million priced the week before.

The bigger picture, however, continued to be disappointing.

For the month as of July 28, agents had sold $1.85 billion, a 22% decline from the same period in June.

This month marked a 41.5% decline from a year ago (July 1, 2011 to July 28, 2011) when sales reached $3.16 billion.

So far this year, sales have amounted to $21.31 billion, a 20% decline from the $26.66 billion at the same time in 2011.

"High-yield ETFs are strong competitors to structured notes," a market participant said. "I also think that a lot of the gap comes from CDs."

But this source predicted an improvement for August.

"Last year month to date was fairly strong before the downgrade of the U.S., so I think August 2012 compared to August 2011 will reflect better numbers," he said.

Risk aversion

However, the choppy market is not helping, sources said.

"It's the decreased risk appetite with the market trading sideways and the situation in Europe that keeps investors on the sidelines, nothing else," the sellsider said.

"Pricing terms are fine. There are some compelling structures out there.

"When you look at equity flows in general, they're down as well, probably by the same amounts.

"It's 100% driven by risk appetite."

This trend is also what's driving the flow of equity index-linked note issuance as well as the preference for structures that offer some level of downside protection, for the most part, leveraged buffered notes, he noted.

More than a quarter of last week's issuance, $263 million, came from leveraged notes with partial downside protection. This is up nearly five-fold from $54 million the previous week.

For the month to date, this type of structure saw its volume rise by 33%, amounting to 29% of the total. It was the only category to grow this month compared to June.

Leveraged notes with partial protection amount to 20% of this year to date's volume and are up 20.15% from last year.

In parallel, equity indexes were the overwhelmingly dominant asset class last week, with 73% of the volume. All asset classes declined in volume for the month, but equity indexes dropped the least, down 12%. They represented 65% of the notional amount.

For the year, indexes continued to grow - they're up 25.5% - while notes linked to single stocks fell by 46.5%.

Entry points

"From a client's perspective, we found historically that whenever there is a contraction of the risk appetite, people tend to be diversified in well-known benchmarks. They cut the amount they're trading, and they constrict the kind of underlying they're using," the sellsider said.

While the S&P 500 is the most popular among all equity benchmarks, not everybody wants to buy at these levels. Andy Valentine Pool, main trader of Regatta Research & Money Management, said that the most wanted equity benchmark is now overbought, even if he is bullish on the United States.

"We have too many S&P, which is why we haven't looked at it. The S&P has run up quite a bit. Investors are chasing yields, driving these things up," Pool said.

Some investors may be bullish on equity but wary of a short-term correction, said Pool.

"We think the economy has improved, and we believe the market will be in a better place a year from now. The problem we're facing now is that we can't get good entry points."

Pool said he sees a lot of deals linked to the MSCI EAFE index or its exchange-traded fund, which trades under the "EFA" symbol.

"The EFA was at its low in December at $46. We're buying at $48. We think that's fair.

"But many of these indexes, including the Russell, have had such a run up," he said.

Pool also noted the thinner buffers.

"The buffers are getting really small. We're not finding 20% or 25% anymore. We find 10% if we find them," he said.

Top deals

While more leveraged deals had some downside protection than not, the top offering last week was leverage only.

AB Svensk Exportkredit priced $70.82 million of 0% Accelerated Return Notes due Sept. 27, 2013 linked to the S&P 500 index. Bank of America Merrill Lynch was the agent.

The payout at maturity will be par of $10 plus triple any index gain, up to a maximum return of 15.33%. Investors are exposed to any losses. The deal priced on Thursday, when the S&P 500 closed at 1,360.02.

The second largest offering was Bank of America Corp.'s $54.04 million of 0% Capped Leveraged Index Return Notes due July 25, 2014 linked to the S&P 500. It provides investors with double leverage on the upside up to a 27.2% cap and a 10% buffer on the downside.

Bank of America Merrill Lynch led the week, as it is common for the end of the month, selling 63.5% of the total volume in 23 deals, including the eight largest offerings.

"That's impressive! That's almost like Michael Phelps with his gold medals," Pool said.

Bank of America Merrill Lynch was followed by UBS, which took 8.22% of the market share, and by HSBC, which had 7.92% of the volume.

"As people get more concerned about risk, they go back to blue chips." - A sellsider

"The problem we're facing now is that we can't get good entry points." - Andy Valentine Pool, main trader of Regatta Research & Money Management

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