Euro fears, volatility, oil price create new appetite for commodities; volume decreases by 47%

By Emma Trincal

New York, May 26 - Investors moved into commodity-linked investments last week amid renewed fears of inflation caused by the credit crisis in Europe while overall issuance dropped by almost half.

Banks issued $472 million in 82 deals during the week ended Friday, down 47% in volume from the week before.

Commodity awakening

Agents sold $107 million of commodity-linked notes in eight deals, or nearly 23% of the total volume, versus 17.5% in the prior week, according to data compiled by Prospect News. However, these figures do not include offerings based on commodity stocks, such as reverse convertible transactions.

The market was prone to a nascent commodity rally with European uncertainty fueling new inflation fears and oil prices dropping to attractive levels, sources said.

"The European crisis is raising concerns about inflation. While U.S. inflation is low, the European bailout means another financial block is printing more money," said a New York sellsider. "It's similar to the U.S. in 2008. It definitely triggers inflation fears."

Top deal is gas

While last week's largest deal at $42.29 million was much smaller than the top deal seen in the prior week (JPMorgan Chase & Co.'s $150 million deal tied to the Contag Beta Alternate index), it repeated the pattern of commodities topping the list of offerings.

"There was a very successful commodity deal the week before. The success of that deal gave more credibility to the asset class. When a deal is successful, others follow," a structurer said.

Last week's top deal referenced energy and was brought to market by Bank of America Corp.

This issuer priced $42.29 million of 0% Strategic Accelerated Redemption Securities due Dec. 2, 2010 linked to the price of the front-month futures contract for RBOB gasoline.

If the price of RBOB gasoline on Nov. 24 is greater than or equal to the initial price, the notes will be called at par of $10 plus a fixed call premium of 17.7%.

If the notes are not called, the payout at maturity will be par unless the final price falls below 95% of the initial price, in which case investors will be exposed to the decline beyond the threshold level.

Commodities-linked notes used a variety of underlyings such as the price of a single commodity, a commodity stock and of course broader indexes.

JPMorgan sold $10.53 million of capped market plus notes due Nov. 23, 2010 tied to the price of gold.

Morgan Stanley sold $10.26 million of knock-out notes due June 3, 2011 tied to the S&P GSCI Excess Return index. Bank of America sold $10 million of Accelerated Return Notes due May 25, 2012 linked to the Energy Select Sector index.

"Similar to doing equity basket deals, people are diversifying their commodity exposure via indexes," said the structurer.

"With the eurozone crisis creating fears around securities, investors are drawn again toward physical assets," said Philippe J.J. Comer, managing director and head of commodity investor structuring, Americas at Barclays Capital.

Energy focus

Many of the largest commodity deals - including the offering linked to gasoline prices, the largest offering of the week - suggest that investors made bullish bets on energy. Two reverse convertible offerings linked to energy stocks stood out.

Deutsche Bank AG, London Branch sold $11.32 million of 14.5% yield optimization notes with contingent protection due Nov. 22, 2010 linked to the share price of Schlumberger Ltd.

Barclays Bank plc similarly sold $10 million of 8.5% reverse convertibles due March 30, 2011 tied to Caterpillar Inc.

"The disaster in the gulf has increased volatility on some of the oil-producing stocks, creating tactical opportunities to sell volatility," the structurer said.

"The decline in oil prices last week was seen as a buying opportunity," said Comer.

"The bargain was especially attractive for those who missed the previous buying opportunity in 2008."

Comer pointed to the sharp decline in oil prices between July 2008 and December 2008 when crude oil fell by 75% to $37 a barrel from $145. Crude oil has dropped by 21% in May.

Volume decline

The overall issuance volume declined by almost half last week, but sources were prompt to downplay the figure as the prior week had been unusually active with $887 million sold without any large exchange-traded note issuance.

The average deal size dropped to $5.75 million from $12.5 million.

However, this number can be partly explained by the disparity in size between last week's top deal ($42.29 million) and the $150 million leading offering priced during the prior week, a gap of over $100 million.

"You can't expect the volume spike of the last two weeks to continue indefinitely," said the structurer.

"Volatility surged in the past two weeks, and investors sold volatility. Volume rose. Issuers sold last week what they usually do in two."

Equity on pause

The same applies to equity, this structurer said.

As commodity deals increased last week, equity-linked notes receded as a proportion of the total, representing 55% of the total issuance versus 63% the week before.

Equity indexes deals dropped to 28% from 40%, and single stock transactions declined to 14.5% from 23%, according to data compiled by Prospect News.

"There were so many deals the week before. You've got to give people time to digest this into the portfolio," said the structurer.

The trend did not stop Goldman Sachs Group, Inc. from offering the second-largest deal, a plain vanilla equity offering consisting of $24.73 million of 0% leveraged buffered index-linked notes due June 10, 2011 linked to the S&P 500 index.

Among equity structures, reverse convertibles remained the product of choice with $126 million issued in 132 deals for 26.7% of the total. The market share was 14.5% in the prior week.

Sources noted that the average deal size for reverse convertibles continued to shrink, falling below the $1 million mark at $950,000 from $1.78 million the week before. As noted before, this trend can be attributed to the "volatility of volatility itself," which forces issuers to reprice their coupons and may delay orders or cause cancellations.

Leverage, no buffer

Investors also showed appetite for leveraged and non-buffered notes. Agents sold $71 million of such deals, or 15% of the total, in 12 deals, according to data compiled by Prospect News.

The largest of those deals came from Eksportfinans ASA, which priced $11.94 million of 0% equity index-linked notes due Nov. 25, 2011 linked to the S&P 500 index via Goldman, Sachs & Co. The payout offered five-time leverage on any index gain subject to a 23.7% cap, but investors were exposed to any index decline on a one-for-one basis.

Out of favor

Two asset classes were clearly out of favor last week: rates and currencies.

Interest rates-linked notes issuance totaled $22 million in eight deals, which amounted to 4.66% of the total.

More significant was the size reduction of those transactions to an average of $2.75 million. As a comparison, the average size for interest rates-linked products observed in the first four months of the year was $11.36 million, according to Prospect News data.

"People do curve trades based on their economic views or bets on Fed moves. The huge changes in interest rates lately come from fears of what's happening in Europe," the structurer said. "It has triggered a flight to quality. Investors are probably frightened to make short-term tactical bets on rates. You don't do interest rate plays based on fear. It's a macroeconomic play."

Currency activity was nearly nonexistent last week with only $3 million sold in two deals.

Barclays priced $2.19 million of 0% buffered digital plus notes due May 24, 2012 linked to the performance of a basket including the South Korean won, Indonesian rupiah and Singapore dollar versus the euro.

Sources said that currency deals have become too expensive to hedge given the momentum around shorting the euro in the eurozone crisis context.

Small but more

Banks issuing more deals albeit smaller in size topped the league tables.

JPMorgan was first with $95 million sold in 23 deals, giving it a 20% market share.

It was followed by Barclays, which priced $88 million in 20 deals for 18.58% of the total.

The average deal size for JPMorgan and Barclays was respectively $4.13 million and $4.4 million.

By comparison, Goldman Sachs, whose average deal size was $11.4 million, came third with $80 million sold in seven deals for 16.91% of the total volume.

"Barclays is stronger in the equity retail structure. Goldman is doing larger deals and institutional deals," the structurer said.

"Barclays has spent a lot of time building a wholesale distribution network. They've invested in a broader distribution channel doing more deals in smaller size."

"With the eurozone crisis creating fears around securities, investors are drawn again toward physical assets." - Philippe J.J. Comer, managing director and head of commodity investor structuring, Americas at Barclays Capital

"You can't expect the volume spike of the last two weeks to continue indefinitely." - A structurer

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