Volume slows to $326 million as second half of month kicks in, but August still strong so far

By Emma Trincal

New York, Aug. 27 – The unusually high pace of activity seen during the first two weeks of August came to a halt last week. Volume was $326 million, a 54% decline from the second week of the month, which had recorded an unusually high volume for the season of $708 million, according to data compiled by Prospect News.

Sources said that as the summer progresses, action may be quieter, but they also stressed the role played by the recent market moves and their impact on volatility and expectations.

The month of August as of Friday remained exceptionally robust compared to last year with $1.96 billion priced, a 44.5% increase from the same period a year ago, the data showed.

Compared to a very strong July – agents sold $2.38 billion through July 22 – the current month to date seems weak, recording a 17% decline. But a lot of it can be attributed to last week’s slowdown.

Overall, the summer has been exceptionally good for issuers, pushing the year-to-date volume well ahead of last year at $29.86 billion, a 26.5% increase from 2013.

Buying on the dip

The difference between last week’s volume and the previous week was largely driven by the equity market, according to sources.

“You saw a strong beginning of August. People had been waiting for a market dip, and we’ve seen the beginning of a slight correction earlier this month. Structured notes buyers used that opportunity to get into the market. A lot of people were waiting on the sidelines and they saw the opportunity. We didn’t see that last week. Equity prices surged to new highs and volatility tumbled,” a market participant said.

A sellsider agreed, saying that investors tend to feel encouraged to buy structured notes just after a sell-off when the market starts to pick up. If the rally becomes too strong, however, caution may prevail.

“If you look at the last couple of months, we saw some volatility come back in to the S&P and you just had a pullback followed by a rally this month, enabling people to jump back in,” this sellsider said.

July was the best month of the year so far, according to the data, with $6.58 billion sold, or 22% of the year’s total volume, according to the data.

“A similar thing happened in January when you had a sell-off in the S&P and then the market rallied back up,” the sellsider said.

January was the second best month of the year with $4.11 billion sold, or 13.75% of the year’s volume.

“In August, you had a pullback in the first week of the month. The S&P hit a low of 1,909 on Aug. 7. After that, the market went up again in the following week. By Aug. 11, you had already come off the lows at 1,936. This is why a lot of people came back to the market in the second week of August, and this is why volume was noticeably high during that week. People jumped back in at lower levels,” the sellsider said.

The 2,000 milestone

As of Aug. 22, the activity has been much stronger compared to August of last year, although things could change when the month closes, he noted.

“We’re doing better than a year ago because you had nothing of that sort in August of last year when the market was down through the month. Volume was at all-time lows. There was nothing exciting to do,” he said.

But the issuance pace could decelerate at the close of the month, he warned, talking about the current week, which began with a new record as the S&P 500 index hit the 2,000 mark for the first time on Monday.

“We may be coming up with reduced activity,” the market participant said.

“People may turn more cautious wondering if the rally has legs, will it break the 2,000 level or are we going to plateau,” the sellsider said.

“I think the week we’re in is probably going to be slower even though it’s the week when most banks close their calendar offerings. The last couple of days have been really slow for some firms,” he added.

“People tend to go back in the market after a dip followed by a rally. But if the market keeps on hitting new highs, they’re more hesitant to move back in unless you get a major break.”

Autocallables, stocks

Autocallable reverse convertibles were the most popular structure last week with 42% of the volume, compared with a 20% average for the year, according to the data.

This trend was in line with the prevalence of single stocks, which accounted for 41% of the volume, almost as much as equity indexes, which made for 43% of the issuance.

Stock deals were small on average: issuers sold $133 million of them in 97 offerings, averaging $1.35 million with sizes as small as $55,000.

“The market is up, and volatility is down. People use single names to get more volatility as they try to boost their returns. Plus if you have a conviction on the stock, it can make for a strong investment case,” the market participant said.

“Most of the time investors use those deals to replace a long position in the S&P 500 as part of their equity allocation.”

The top single-stock offering and the third in size last week was Deutsche Bank AG, London Branch’s $19.78 million of 11.5% airbag autocallable yield optimization notes due Aug. 31, 2015 linked to the common stock of GT Advanced Technologies Inc. The notes are autocallable quarterly if the share price is at or above its initial level on that day. A 55% final barrier applies at maturity.

“When a client has a certain target they’re trying to achieve and it’s not doable, they have two options,” the sellsider said.

“They can increase volatility by creating a worst-of basket, or they can use a note tied to an individual stock. In both cases they get more volatility than a broad-based index. So there is a series of possible steps to take in order to increase volatility: you start with an index, then a basket of indexes, then a worst-of basket and finally you go for the individual name.

“Clients have evolved as volatility has shrunk. They try to get more volatility and are willing to take on more risk in order to do so.”

Protection wanted

Investors last week showed more caution as illustrated by the wider use of leveraged notes with partial downside protection (barrier or buffer) compared to unprotected leverage, the data showed.

Leveraged notes with either a barrier or a buffer accounted for 17.5% of last week’s volume, versus 1.5% for notes in which investors had no protection on the downside. On average for the year to date, these two categories of structures are evenly split, each representing about 16% of the volume.

“It’s all based on expectations,” the market participant said.

“You expect the market to go down, you ask for a buffer. If you see a continuation of the bull trend, you want more upside, a higher cap and you’re willing to give up the protection.”

The sellsider agreed, saying that the use of buffers and barriers is a result of investors’ risk profile.

“It’s client-driven. If the client is risk-averse, the buffer will come in. If they’re willing to take some risks, the non-buffered structure will be popular,” he said.

“It has to do with market sentiment. We had last week major news stories that were pretty negative on the geopolitical front. You had Russian troops crossing the border into Ukraine and this journalist who was assassinated. That made some people uneasy on how these things will affect the market.

“The market meanwhile has come off its lows and has reached new highs above the 2,000 mark. This made people a little bit more eager to get some protection.”

Top deals

Neither of the two largest deals were based on the S&P 500 index last week. One was a country-specific equity play, and the other was a commodity offering.

Goldman Sachs Group, Inc. brought to market the top deal with $34.9 million of 0% notes due Nov. 25, 2014 linked to the Topix index, a tracker note giving investors the return of the index minus an adjustment factor.

The offering is a repeat deal. Goldman Sachs periodically brings this deal to market, according to the data. Agents have sold 24 deals linked to the Topix index this year to date, and Goldman Sachs priced 15 of them, the data showed.

“If someone wants to play the Japanese recovery story, it’s a good way to get exposure via a simple delta one structure,” the market participant said.

“The Topix has almost 1,800 constituents. It gives a much better representation than the Nikkei, which tracks only 225 stocks.”

Deutsche Bank priced the No. 2 deal, $25.83 million of 0% capped knock-out notes due Jan. 4, 2016 linked to WTI crude oil futures contracts. The payout at maturity will be par plus double the commodity return, subject to a 20.2% cap. The notes offer a 5% contingent minimum return, but the condition is a final price at or above the 85% knock-out level; otherwise, investors are fully exposed to losses.

The sale of commodity-linked notes is on the rebound this year, growing by 5% to $1.49 billion from $1.22 billion last year, according to the data. Part of it is due to a few larger oil deals that priced since July in excess of $30 million, including a $103 million Barclays buffered notes offering that priced Aug. 15.

The increasing use of individual commodities rather than broad commodity indexes is a new trend this year, said the market participant.

“I can only speculate that it’s because we’ve seen the performance of individual commodities, like oil or gold, diverge quite a bit from the benchmarks,” he said.

“Look at agriculture. It’s now down in price. But WTI futures offer good pricing right now as the forward curve is on backwardation. Aside from the bullish play on oil, it could explain why oil deals are popular right now.

“Just like with stocks, if the client happens to have a particular view on a commodity, it’s better to do it individually than through a broad-based index because with more volatility, you increase the odds of scoring a higher return.”

“People tend to go back in the market after a dip followed by a rally.” – A sellsider

“WTI futures offer good pricing right now as the forward curve is on backwardation.” – A market participant

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