Issuance slowdown signals investors' lack of conviction on market direction, sources say

By Emma Trincal

New York, Feb. 8 - Issuance fell by nearly 50% year to date compared to last year, but sources are not too concerned. They see in the trend a sign that investors are adjusting to a range-bound market marked by a rally that many are convinced may not last.

"Volume is down, and it reflects an uncertain market. People have turned more neutral for the next 12 months. As bearish as they would want to be, the market is still up. They're simply moving away from leverage and want downside protection. That's the change in sentiment," a structurer said.

A market participant was more bullish.

"Volume in structured products is down since the beginning of the year, but it's true in general. Equity is sitting on the sidelines; other asset classes are sitting on the sidelines. The January rally has caught many investors off guard. February is going to be a better month. My bet is that 2012 will be a good year," this market participant said.

For the structurer, the shrinking volume is a sign of adaptability on the part of investors that may not reflect any long-term pattern.

"Demand is down, but what's important is why demand is down. I'm always an optimist, and I think it's actually a positive. It's based on the backdrop of the marketplace. Investors are savvier about structured products. They use the products in a more tactical way. The market has matured," the structurer said.

From Jan. 1 through Feb. 4, agents sold $3.05 billion in 687 deals, a 47% decline compared to the $5.76 billion issued during the same period last year in 600 deals, according to data compiled by Prospect News that excludes exchange-traded notes and lightly structured interest rate-based products such as step-ups, fixed-to-floaters and capped floaters.

Volume for the month to date was $148 million, a 71% decline from the first four days of January, which a source said is not an anomaly given deals that should have closed at the end of last year ended up being posted early in January.

During the week ended Feb. 4, $235 million of notes were sold, a 82% decline from the week before, which saw the pricing of $1.31 billion.

Brakes on stocks

Reverse convertibles have declined the most year to date. They fell 70% to $187 million in 2012 from $617 million at the same time in 2011.

This decline goes hand in hand with a shrinking volume in single stock-linked notes between this year and last year, the data shows.

While equity index deals have declined in volume by 26%, single-stock issuance is down by 62% from last year, the data shows.

"With the market offering upside potential, people shy away from capped products, which is one of the reasons reverse convertibles are less in favor," the market participant said.

"There's also a lot of pressure from Finra for single-stocks," he noted.

The Financial Industry Regulatory Authority, Inc. fined several banks last year for "unsuitable sales" of reverse convertibles and issued an investor alert on this type of product.

"But overall, I just think that people want participation in the markets," this market participant said.

Market savvy

For the structurer, the decline in sales of reverse convertibles does not necessarily spell bad news.

"I don't think the drop in reverse convertible sales is due to the regulator," he said. "The primary reason is how the market has recently evolved.

"And the fact that people are not buying them right now is actually a good sign. If they did, it would mean that they're still trying to figure out what these structures are all about and that all they're doing is stretching for yield, which they shouldn't.

"I'm confident that investors understand these products better."

The structurer noted that volatility has been on the decline in the second half of last year as well as year to date.

The CBOE Volatility index, or VIX index, which measures implied volatility on S&P 500 options, reached its 52-week high at 48 in early August. It has fallen by 61% since then to 18.5.

"The market has been up over the past six months, and volatility has dropped a lot," the structurer said.

"And when you buy a reverse convertible, you're selling volatility. People realize that it's not the opportune time to do those deals.

"The lower volatility has reduced the pool of stocks that produce attractive coupons. The list of offerings is getting shorter. The quality of names keeps on declining.

"The fact that investors are backing away is actually a good thing."

Leverage on hold

Another type of structure that is also down in volume year to date compared to the same time last year is leverage with no downside protection, according to the data.

Those deals amounted to $1.18 billion last year and $419 million this year, a 65% decline.

"Again, the decline of pure leverage shouldn't be a surprise based on what the market has done over the past six to nine months," the structurer said.

"We're coming up against some technical resistance. People aren't so much interested in leverage.

"Investors have become more conservative, and they're looking for notes with some downside protection."

Lower levels of volatility, according to this source, are the main driver behind the decreased supply of leveraged deals.

"With leverage, you're selling at-the-money puts to give you the one-for-one downside," he said.

"You're also buying multiples of call spreads for the leverage.

"High volatility makes both the put sale and the call spread more advantageous. On the put, you're getting a higher premium, and on the call spread, the high volatility would help compress the price, which you don't have now."

Range bound

The structures investors seemed to favor last week and recently have been those that enable them to trade range bound, sources said.

Two autocallable notes - the No. 1 and No. 3 deals for last week, both identical in structure and both sold by JPMorgan - illustrated investors' interest in expressing sideways views.

JPMorgan Chase & Co. priced $22.77 million of 0% review notes due Feb. 21, 2013 linked to the S&P 500 index. The notes will be automatically called at par plus a 12.6% per year call premium if the index closes at or above the initial index level on any of the quarterly review dates.

If the notes are not called, the payout at maturity will be par if the final index level is at least 90% of the initial level. Otherwise, investors will lose 1.1111% for every 1% that the index declines beyond 10%.

Deutsche Bank AG, London Branch priced $13.94 million of notes with the same terms, also distributed by JPMorgan's franchise.

The second largest deal last week was based on currencies.

Bank of America Corp. priced $15.23 million of 0% Currency Market Index Target-Term Securities due Feb. 4, 2014 linked to the Chinese renminbi/dollar exchange rate measure, which represents a long position in the renminbi relative to the dollar.

The structure is fully protected on the downside and offers a 1.3 times leverage factor on the upside.

Deutsche Bank priced $11 million of securities due March 7, 2013 linked to the Dow Jones - UBS Commodity Index Total Return, which was the fourth largest offering last week. The structure delivers a monthly coupon of one-month Libor minus 16 basis points. The notes are putable any time.

The payout upon redemption or at maturity will be par plus triple the sum of the index return minus the TBill return minus an adjustment factor.

Last week's deals were smaller in size. Only seven offerings exceeded $10 million, versus 38 the week before. There were no deals in excess of $50 million, and four such offerings priced the week before.

JPMorgan was the top agent last week with $49 million, or 21% of the total, sold in 10 deals. It was followed by Wells Fargo, which acted as agent for deals issued by Wells Fargo & Co. as well as notes issued by Royal Bank of Canada. Bank of America Merrill Lynch was the No. 3 agent.

"February is going to be a better month. My bet is that 2012 will be a good year." - A market participant

"The fact that investors are backing away [from reverse convertibles] is actually a good thing." - A structurer

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