Issuance mild amid bond sell-off, equity volatility; investors focus on commodities, rates

By Emma Trincal

New York, June 10 – It was a slow week in structured product issuance. The month kicked off, but the market overall was nothing but quiet, sources said.

Agents sold $223 million in 72 deals with only one offering in excess of $20 million, compared with 25 during the previous week, according to data compiled by Prospect News.

Bond volatility continued to rock markets with yields spiking in both Europe and in the United States. On Thursday, the 10-year Treasury hit a new high at 2.42%. The trend continued this week with the 10-year Treasury yielding 2.48% on Wednesday.

Equity markets were choppy last week amid uncertainty about Greece and as the market waited for the May jobs report to be released on Friday. The better-than-expected job picture sent stock prices down as it raised the odds of a Fed rate hike this year.

Commodities, rates

“As investors expect higher yields, bets on interest rates are becoming increasingly popular,” said a fixed-income structurer.

In market share, the numbers confirmed his view even if volume was extremely weak as a whole.

Two interest-rate-linked offerings captured 11% of the volume last week. They were dwarfed, however, by a more than $70 million commodities deal, which pushed commodity-linked issuance to 33% of the total volume.

Both rates and commodities typically don’t make such high numbers. The annual average is less than 3% for commodities and 3.4% for rates, according to the data.

In the same vein, equity-linked notes, which so far this year make for 87% of the market, were half of that last week with a 45% share.

Big Barclays

The largest deal was a repeat offering, which has gathered large bids in recent weeks.

Barclays Bank plc priced $72.53 million of additional 0% daily liquidity notes due June 2, 2017 linked to the Bloomberg Commodity Index 3 Month Forward Total Return.

The company priced $111.11 million of the notes on May 28. The total issue size is now $183.64 million.

The notes, which are putable at any time, offer a one-to-one exposure to the index minus fees.

J.P. Morgan Securities LLC and JPMorgan Chase Bank, NA were the agents.

“It’s done by JP Morgan. ... Chances are it’s retail,” said an industry source.

“Believe it or not, retail clients understand the three-month concept. The carry is a concept people understand now. They’ve heard about it for the past 10 years. Whether you talk about contango, and this is an index designed to reduce contango, or volatility, investors pretty much understand the concept. It’s not that complicated,” he said.

Smart index

By “three month,” he was referring to the Bloomberg Commodity Index 3 Month Forward Total Return, an index that uses futures contracts three months later than the normal month of delivery.

Commodities indexes are based on futures contracts, which are rolled as they expire and bought again at a further-dated part of the futures curve. The futures curve is in contango when the cost of rolling increases, which occurs when the spot (or nearby) prices are cheaper than the futures prices. Contango, which represents the cost of carry, erodes long positions. The three-month roll used in the index is a technique employed to reduce the extra cost of contango, he explained.

CMS deals

Down on the list of deals was a pair of 10-year Constant Maturity Swap rate deals, which competed with one another.

Goldman Sachs Group, Inc. priced $13.85 million of 10-year fixed-to-floating-rate notes linked to the 10-year CMS rate.

The interest rate was 3.5% for the first three years. After that, the interest rate was equal to the 10-year CMS rate. The payout at maturity was par.

JPMorgan Chase & Co. priced 10-year fixed-to-floating notes for $10.51 million also tied to the 10-year CMS rate.

The coupon was 3% for the first two years. After that, it was 0.95 times the 10-year CMS rate. The payout at maturity was par.

Those deals were No. 2 and No. 4 in size, respectively, evidencing the sluggish action seen last week.

But sources paid attention to the re-emergence of rate issuance as seen over the past few weeks.

“As low yields have kept many investors to the sidelines, they now have an opportunity to re-enter the market,” said the fixed-income structurer.

The use of CMS rates versus CMS spreads has become more common than in previous months, according to the data.

This may signal expectations of a flatter yield curve, as a Fed rate hike would affect short-term yields, sources said.

These market anticipations were exacerbated on Friday when the government released a stronger-than-expected job report for May.

A new tool

But some structurers did not read too much into investor sentiment when it came to the nature of rate deals issuers are bringing to the market.

“I think it’s like in equity. Each investor pays attention to one factor, one asset they want exposure to,” the fixed-income structurer said.

“What’s clear is that people are getting used to the idea that interest rates are going to rise. They’re betting on that.”

The CMS deals, which in general are principal protected, are also easier to structure, said the industry source.

“In general, higher rates really help those. It just gives the issuer much more flexibility. It’s true that there is no impact on principal-at-risk products. But for principal protected, it’s a big help. You’re likely to see more CMS deals, more principal-protected notes if rates continue to go up,” he said.

Income

On the equity side, rising volatility continued to favor short-volatility structures, especially autocallable reverse convertibles, which accounted for nearly a quarter of the volume.

The top deal in this category, and the third in size for the week, was brought to market by Deutsche Bank AG, London Branch in an $11.3 million offering of 6% autocallable securities due Sept. 9, 2016 linked to the lesser performing of the Russell 2000 index and the iShares MSCI EAFE exchange-traded fund.

The notes would be called at par plus the coupon if each underlying component closed at or above its initial level on any quarterly observation date.

The payout at maturity was par unless either component finished below the 80% barrier level, in which case investors would lose 1.25% for every 1% decline of the worse-performing component.

JPMorgan, which priced the only large deal of the week, was the No. 1 agent with $111 million sold in 13 deals, or 50% of the volume. It was followed by Goldman Sachs and Barclays.

“What’s clear is that people are getting used to the idea that interest rates are going to rise.” – A fixed-income structurer

“Chances are it’s retail.” – An industry source on Barclays’ notes linked to the Bloomberg Commodity Index 3 Month Forward Total Return

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