Volume doubles to $887 million while single-stock, reverse convertible deals make strong push

By Emma Trincal

New York, May 19 - Issuance doubled during the second week of May to $887 million from $432 million while choppy markets led to a strong comeback of reverse convertible notes.

Single-stock preference

Single-stock-linked products prevailed with $209 million in 76 deals, which represents a third of the deals and a quarter of the volume. These figures contrast with the week before, when only 9% of the offerings were linked to a single stock, according to data compiled by Prospect News.

Under the single-stock umbrella, reverse convertibles led with approximately $129 million sold in 72 deals during the week ended Friday, or 14.5% of the total versus 9% the week before when all single-stock deals were reverse convertible structures.

While Morgan Stanley priced the largest reverse convertible offering with $29 million of 15% Equity LinKed Securities due Nov. 9, 2010 linked to United States Steel Corp., sources emphasized that the big story was not the rise in reverse convertible issuance, a trend sources had predicted the week before, but rather the shrinking of the size of the average reverse convertible deal.

Smaller reverse convertibles

The average reverse convertible deal size was $1.78 million last week. It was $2.37 million the week before. "That's significant, that's a 25% reduction in size," noted Michael Iver, a former JPMorgan structurer, from data compiled by Prospect News.

"The volume and number of reverse convertibles skyrocketed as a result of the rising volatility," Iver said. "But because volatility itself was choppy, it reduced the amount of time dealers had to sell their offerings. That led to smaller deals."

Looking at the gyrations of the CBOE Volatility index, or VIX, which tracks the volatility of the S&P 500 index, Iver said that the benchmark went from 26 to a 35 high, down to 28 and then back to 35.

"You have a coupon for a 35% volatility. Volatility goes down to 28. You need another coupon," Iver said. "Changing those coupons may make you lose some customers. Some orders will get canceled," he said.

"When volatility goes down and you have to reduce the coupon, your deal size may shrink. You have to call customers and reconfirm the orders. A volatile volatility makes it difficult to premarket deals," he said.

Autocallables are back

During the week preceding last week, issuers did not price any autocallable deals. This changed last week with three deals totaling $48.67 million, or 5.5% of total issuance.

UBS AG, London Branch priced $24.61 million of 0% autocallable optimization securities with contingent protection due May 16, 2011 linked to the common stock of Apple Inc.

UBS also sold on the behalf of JPMorgan Chase & Co. $21.06 million of 0% autocallable optimization securities with contingent protection due May 16, 2011 linked to the common stock of Merck & Co.

"Autocallables are instruments to create yield out of equity. Using volatility by selling some of the upside can give you a nice coupon," said Iver. "These are household names. People own Apple or Merck. Those notes exist to create yield enhancement out of a core portfolio position. These are long-term strategies, not opportunistic or tactical plays," Iver said.

Bank of America Corp. priced a $33.61 million offering of 10% STEP Income Securities due May 27, 2011 linked to U.S. Steel. The single-stock deal, neither an autocallable nor a reverse convertible structure, was however in the top 10 deals list.

Commodity hit

Another trend for the week was a relative popularity of commodity-linked deals compared to prior weeks, with $166 million sold in four deals, or nearly 20% of the total volume versus 8% recorded during the week before.

However, most of it came from a very large deal, the largest of the week all asset classes included.

JPMorgan priced $150 million of 0% return notes due May 20, 2011 linked to the J.P. Morgan Contag Beta Alternate Benchmark Class A Excess Return index.

The payout at maturity will be par plus the index return, plus a fixed additional amount of $5.86 per $1,000 principal amount, less a fixed fee of 0.55%. Investors will be exposed to any index decline.

The index is intended to capture the return of the synthetic exposure to a notional basket of 19 commodities. The goal of the index is to limit investors' exposure to adverse slopes of the futures curves for the underlying commodities, in particular, limit the negative impact of contango, according to the filing.

Commenting on the deal, Iver said, "It's a diversified basket, and it's a play on global economic growth."

Among the four commodity deals, three were linked to an algorithmic index. Algorithmic index-linked notes are increasingly popular with commodity deals rather than the traditional use of futures contracts, sources noted.

"The linking to indexes provides diversification and less exposure to the supply and demand of a single contract," said Iver, commenting on the trend.

European values

Deutsche Bank AG, London Branch priced the third- and fourth-largest deals of the week with two notes offering a bullish exposure to the 50 largest stocks in the eurozone.

The bank priced $61.43 million of 0% knock-out notes due Nov. 16, 2011 linked to the Dow Jones Euro Stoxx 50 index. It also sold $39.7 million of similar notes with the same maturity date and underlying but slightly different features regarding the size of the buffer and the level of the minimum payment if the knock-out event fails to occur.

The popularity of those two deals offered a contrast with the weakness of supply in currency deals linked to the euro, some sources observed.

Some sellsiders explained that there is demand for bearish bets on the euro, yet very few of those deals got priced.

On the other hand, the low valuations of European stocks attracted some investors in a somewhat "contrarian" way, sources noted.

Commenting on the popularity of the Deutsche Bank offerings on the European stock benchmark, a structurer said, "The euro is falling, so that could be a play on export-induced recovery in the eurozone. Some countries like Germany depend a lot on exportations for their growth. If the euro depreciates further, it could be good for the eurozone in that regard."

But a sellsider saw in the trend a typical value play: "It's a little bit like buying Goldman Sachs when the stock market gets beat up," he said. "You get cheaper options, which ultimately are passed through to the client."

There were only two currency deals last week totaling $11 million, or 1.2% of the issuance.

"Options on currency are definitely expensive. Everybody wants to do the same thing. It's also because retail investors do not trade or hedge currency positions that much," the sellsider said.

"The U.S. retail investor is not so interested in the euro trade. He's more inward-looking.

"But European equity is different. Traditionally, global equity has been popular among retail investors," he added.

Both currency deals were brought by Deutsche Bank and offered bullish bets on a basket of currencies against the euro.

JPMorgan tops

JPMorgan led the league tables with $332 million sold in 19 deals, a 37.43% share of the total with its $150 million commodity deal absorbing almost 18% of the total market all by itself.

Goldman Sachs Group, Inc. priced the second-largest deal with $78.65 million of 0% index-linked trigger notes due Nov. 21, 2011 linked to the S&P 500, securing the second slot in the ranking with $152 million sold in nine deals for 17% of the total.

Morgan Stanley was third. The bank only priced six deals but upsized a few.

For instance, Morgan Stanley upsized its range accrual notes due May 18, 2025 linked to the Consumer Price Index and the S&P 500 index to $40 million from $25 million. This was the fourth-largest transaction of the week.

"The volume and number of reverse convertibles skyrocketed as a result of the rising volatility." - Michael Iver, a former JPMorgan structurer

"The U.S. retail investor is not so interested in the euro trade." - 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.