September slower than August so far; little action seen except for $128 million Scotiabank deal

By Emma Trincal

New York, Sept. 25 - Agents sold $356 million last week, or 7% less than the previous week, and one giant deal priced by Bank of Nova Scotia for $128 million contributed to more than a third of the total volume, according to data compiled by Prospect News.

It was the second time in a row that the market was saved by a mega-deal. The previous week, Barclays Bank plc brought to market the biggest commodities offering of the year so far, a $103 million deal linked to Brent crude oil.

Bank of Nova Scotia, usually not a big player, topped the league tables last week, followed far behind by Bank of America and UBS.

The deal was noteworthy as it used a recently launched index, the Raymond James Analyst Current Favorites Total Return index, demonstrating investors' increased appetite for stocks and opportunities in stock-picking, sources said.

The Federal Reserve's unexpected announcement on Wednesday that it will not reduce its bond-buying program had more of a direct impact on equities than structured notes, fueling an immediate rally and pushing down volatility, according to sources. However, the uncertainty around the direction of interest rates is not conducive for structured products issuance, a sellsider said.

September's volume as of Sept. 21 has declined compared to the same period in August, the data showed. Agents have sold $1.11 billion this month, a 15% decline from the $1.31 billion sold last month.

"We did see some slowdown in activity, but it's hard to tell why," a structurer said.

The S&P 500 index surged after Wednesday's announcement, up 1.21% for the week. Sources were not sure how to interpret the impact of the Fred's surprise decision on structured products volume.

The Fed factor

"People have certainly been taken aback by this non-tapering, and now we have to move on with more uncertainty," a market participant said.

"It was certainly a close call, but $15 billion less of bond purchases wouldn't have made such a difference anyway.

"We think the tapering will happen anyway. In Europe, the ECB has been reducing its balance sheet, and it hasn't had an impact on the economy. I don't know what Bernanke is so afraid of. Eventually, the whole liquidity injection will have to end. Financing the U.S. debt with low interest rates is not sustainable, but you can understand why it's not much in the interest of the U.S. economy to see higher rates. The market is a sick man, and the Fed is a surgeon injecting the drug. You wonder how long the patient can take this kind of drug."

This source attributed the low activity in structured products to the low volatility, a consequence itself of a sustained bull market.

"September usually is better than August. Not this year," he said.

"I think it's because of the continued low volatility. People don't want to go with barriers that offer poor protection. Even autocallables are not so attractive anymore because the barriers can't be set low enough. Volatility being so low, people are not very keen on structured products. It's hard to put together structures that deliver yield enhancement. Conditions are not right.

"With the Fed hesitations and the uncertainty around the tapering, people are in a wait-and-see mode.

"We don't see much volume. We see much more volume in bonds, not just in interest-rate-linked notes but all fixed income in general. With structured notes we see an increase in the appetite for leveraged floaters, CMS spread deals because if rates do increase, you won't suffer loss of value in your asset. We see a lot of new issues in bonds in general."

The sellsider said that so far this month, volume has been unusually weak. He attributed the slowdown to interest rates.

"It's not the end of the month yet, but it doesn't feel that it's going to be a strong month, that's for sure," this sellsider said.

"Why? I don't really know the answer. People are not just interested in anything we show them. The deals are on a holding pattern. And you had of course this flip flop with the Fed. Rates are lower now, and it's hard to create something new with lower rates. The tapering noise was fairly good for the market. It pushed rates higher. Now we can't get participation up because we have lower rates. The only way you can do it is by lengthening the terms, sometimes to six years."

Last week's Fed announcement, while unexpected, had a limited impact on structured products issuance for that week, he said.

"The market wasn't really moving anyway. I don't think [the Fed] was the catalyst," he said.

"That said, if the Fed started to taper, we would start to see some action. But for now, everyone seems to be invested where they want to be. It's hard to get new money in."

Year-to-date volume has increased by 2.41% to $26.56 billion from $25.94 billion during the same period of last year, according to Prospect News data.

Big Scotiabank deal

Bank of Nova Scotia priced the top deal of the week, $128 million of equity-linked notes due Sept. 21, 2016 tied to the Raymond James Analyst Current Favorites Total Return index.

The notes priced at 103% of par. The payout at maturity will be par plus the index return. Investors are fully exposed to losses. It is a tracker note linked to an index based on a list compiled by Raymond James of stocks rated "strong buy" or "outperform."

"People value research," the structurer said.

"Raymond James has a good name in equity research, and people like that. They need an edge. And it's a new index.

"It was a huge size."

Given the size of the deal, baskets of stocks for a change represented the top asset class used last week. Next were single stocks, which continued to compete with and last week prevail over equity indexes. Stocks made for 33% of the market versus only 18.3% for equity indexes, according to the data.

For the year, single stocks represent 22.5% of the total versus 55% for equity indexes, but their growth has been significant: They are up 16.7% versus a 0.84% decline for equity indexes, according to the data.

Bids on stocks

The No. 2 and No. 3 deals last week, which were much smaller in size, were both linked to stocks.

Barclays priced $25.64 million of 9% STEP Income Securities due Oct. 3, 2014 linked to the performance of Hartford Financial Services Group, Inc. shares. Interest is payable quarterly.

If the price of Hartford shares finishes at or above the step level, 109% of the initial price, the payout at maturity will be par of $10 plus 2.92%. If the stock finishes at or above the initial value but below the step level, the payout will be par. Investors are fully exposed to any losses.

BofA Merrill Lynch was the agent.

The other one, an autocallable reverse convertible, was brought to market by Citigroup Inc. It was $20.7 million of 14.5% autocallable equity-linked securities due Sept. 25, 2014 linked to United States Steel Corp. Interest is payable quarterly.

The call is triggered at or above the initial price on any of three quarterly observation dates.

If the notes are not called and the final share price is at least 75% of the initial share price, the payout at maturity will be par. Otherwise, the payout will be a number of U.S. Steel shares equal to $10 divided by the initial share price or, at the issuer's option, an amount in cash equal to the value of those shares.

Issuance for leveraged deals declined by nearly a third from the prior week with $50 million in eight deals, or 14% of the total. A majority of those offerings, with the exception of two, offered some form of downside protection with a buffer or a barrier.

One of those partially protected products and the No. 4 deal for the week was Morgan Stanley's $18.83 million of 0% Buffered Performance Leveraged Upside Securities due March 26, 2018 linked to the Dow Jones industrial average.

The payout at maturity will be par plus 110% of the index return. Investors will receive par if the index falls by up to 25% and will lose 1% for every 1% decline in the index beyond 25%.

Principal-protected structures have become rare, according to the data. Only 29 principal-protected note offerings have hit the market so far this year totaling $171 million, or less than 1% of the year's volume.

Sources, however, noted that the No. 5 offering last week offered full downside protection. It was Royal Bank of Canada's $15 million of 0% market-linked notes due Sept. 26, 2022 linked to a global index basket. The basket consisted of the S&P 500 index with a 55% weight, the MSCI EAFE index with a 30% weight and the Russell 2000 index with a 15% weight.

If the basket return is positive, the payout at maturity will be par plus 101% of the gain. If the basket falls, the payout is par.

Bank of America, the No. 2 agent last week, sold $44 million, or 12.27% of the volume. It was followed by UBS with $42 million and 11.80% of the total.

"People are in a wait-and-see mode." - A market participant

"The market wasn't really moving anyway. I don't think [the Fed] was the catalyst." - A sellsider

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