Week slow, but low activity considered blip; strong bid seen for hybrid range accrual notes

By Emma Trincal

New York, July 6 - U.S. structured products agents wrapped the week ended Friday in a holiday mood. Volume fell 41% to $763 million excluding exchange-traded notes, which surprised no one given the exceptionally strong issuance activity observed during the week ended June 24 when ex-ETN sales reached $1.28 billion, according to data compiled by Prospect News.

Investors last week showed a strong interest in range accrual notes. The two top deals priced in this category in large sizes of $103 million and $85 million.

Ready to leave

"Everything got priced the week before. No one was there last week. Even this week, a lot of people are out," a sellsider said.

"It's a symptom of the holiday," said Jim Ziniel, investment consultant at SIP America, a distribution firm.

"Issuers want to get the structures out prior to people going on vacation. The week of the 4th of July is always low.

"The fact that volume surged the week before is a good indicator that last week was a momentary blip."

Ahead of 2010

Volume on a year-to-date basis rose to $22.74 billion excluding ETNs. This is up nearly 7% from last year's first half, which saw $21.27 billion of issuance.

"I'm optimistic on the volume," Ziniel said.

"I think that before the end of the year, we're going to see, just like two weeks ago, volume increasing pretty substantially.

"There is going to be a summer low in terms of pricing activity. But as we get into August, September, volume will spike substantially before the end of the year."

Not everyone shares this optimism.

"We're up 7% for the year. Well, maybe we'll end the year up 10%. I don't know, but I'm not too optimistic. The last month and a half has been pretty bad," the sellsider said.

"Volatility has been on the decline. It may peak intraday, but there is no long-term trend. And that kills a lot of deals, especially reverse convertibles."

Range accrual flavor

The most popular deals last week were range accrual notes.

Those products were not purely interest rates structures - as they typically are - but hybrid, incorporating an equity element. The structure is capital protected and long term and offers a high first-year fixed coupon followed by a coupon contingent upon the condition that the underlying rate and equity components each stay within a predefined range.

JPMorgan Chase & Co. priced $103 million of range accrual notes due June 30, 2026 linked to six-month Libor and the S&P 500 index. It was the largest offering of the week.

The coupon is 7% for the first year. After that, it will accrue at 7% per year on each day that six-month Libor is between 0% and 6% and the S&P 500 index is at or above 920. The payout at maturity will be par.

The notes are callable at par on any interest payment date after one year.

"A few banks have done it before: Morgan Stanley, Barclays, Goldman. Now it's JP Morgan. These deals are penetrating the private banking channels," the sellsider said.

The second-largest deal was brought to market by Morgan Stanley, which priced $85 million of CMS curve and S&P 500 index-linked range accrual notes due June 30, 2026.

The coupon is 11% for the first year. After that, the rate will accrue at four times the spread of the 30-year Constant Maturity Swap rate over the two-year CMS rate on each day that the S&P 500 is at least 935, up to a maximum rate of 12% per year in any interest payment period. The payout at maturity will be par.

"Those hybrid range accrual [notes] are on the rise. Everybody is chasing yield," the sellsider said.

"A pure rate product would give you 5% at the most. But these hybrids with the equity part can boost your coupon quite a bit. By introducing an S&P 500 condition, you can get a 7% or even 8% coupon.

"People buy these notes for the huge coupon paid on year one."

Ziniel said that the demand for these structures reflected the lack of clear direction in the market.

"Hybrid notes are popular because a lot of clients and advisers aren't really sure where to put their money," he said.

"This sentiment is evident in these hybrid types of products when you think rates will stay relatively low in the short term and when you believe that the S&P will maintain a certain level, but you're not sure if it's going to be accelerating one way or the other. It's hard to figure out which way it's going to go.

"We're seeing a lot of range accrual, steepeners and fixed-to-floaters. There's demand for that."

Equity decline

Equity as an underlying asset class declined in volume last week by half to $404 million and as a percentage of the total to 53% from 71% the week before. It was well below the 67% market share recorded for the year to date.

Equity index-linked notes declined the most - down 72% to $171 million for 22% of the total. This reversed what was seen during the prior week, when this asset class accounted for nearly half of the volume.

The third-largest deal was an equity index offering. HSBC USA Inc. priced $49.76 million of 0% trigger performance securities due June 30, 2021 linked to the S&P 500 index. There is a 1.93 times leverage factor on the upside and a 45% barrier on the downside.

Stocks maintained their volume, slightly up at $271 million versus $233 million the week before.

UBS AG, London Branch priced $25.8 million of trigger phoenix autocallable optimization securities due June 29, 2012 linked to the common stock of JPMorgan. It was the biggest stock deal and the No. 5 deal for the week.

The coupon is 13.69% per year, payable quarterly only if JPMorgan stock closes at or above the 80% trigger price on a quarterly observation date.

At maturity, investors will receive par plus the contingent coupon if JPMorgan shares finish at or above the trigger price; otherwise they will be fully exposed to losses.

More caution

Leveraged deals with no protection nearly vanished. They fell 93% to $26 million from $350 million, a sign that investors are turning more skittish, sources said.

"Many people are expecting a 10% to 20% correction in the coming weeks, so they are less inclined to get leverage without downside protection," the sellsider said.

The volume of leveraged deals with downside protection declined too but to a smaller extent. They fell by 36% to $161 million.

More significantly, many of the top deals priced last week were capital guaranteed.

"We see a trend where advisers are looking for some protection or buffer, and we think this trend will increase as the year unfolds," said Ziniel.

"Protection versus no protection depends on where the market is trading.

"When investors think there's going to be a significant rebound, they want to participate to the upside with leverage and they're willing to give up the downside protection."

Troubled reverse convertibles

Reverse convertibles last week remained even at $175 million, up only 1.7% from the week before, which recorded $172 million sales.

"Reverse convertibles have been flat most of the year," the sellsider said.

Year to date, reverse convertibles have declined in volume by 13.5% to $3.35 billion.

The number of deals is also down at 1,250, versus 1,941 for the same period of 2010. While reverse convertibles amounted to 18.2% of the volume last year, they now represent 14.7% of sales.

The sellsider blamed the decline in volatility.

"Volatility hasn't picked up. It hasn't helped reverse convertibles that are short volatility," he said.

"What you see right now are fewer, bigger deals. It's not easy to price, so issuers are selling big offerings on popular names that are easy to price."

As a rally lifted the S&P 500 by 4.7% last week, volatility as measured by the CBOE Volatility index, or VIX, declined by 23% to 15.87 from 20.56.

The VIX peaked at nearly 30 in mid-March and declined to less than 15 at the end of April. The "fear index" traded sideways in May and has been on a downtrend since mid-June.

JPMorgan tops

JPMorgan was the top agent last week with $194 million sold in 30 deals for 25.41% of the total volume.

It was followed by UBS, selling $182 million in 23 deals for a 23.81% market share, and by Barclays, which priced 24 deals totaling $120 million and representing 15.77% of the total.

Merrill Lynch was the No. 1 agent the week before.

"The fact that volume surged the week before is a good indicator that last week was a momentary blip." - Jim Ziniel, investment consultant at SIP America, a distribution firm

"Reverse convertibles have been flat most of the year." - A sellsider

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.