Volume is up 23% for month; investors bid on CMS plays, leveraged notes without buffers

By Emma Trincal

New York, June 12 - Agents sold $392 million in the week ended Friday, a slow pace compared to the $1.66 billion issued the week before for the end of last month, but a decent level for the early part of the cycle compared to May, according to data compiled by Prospect News.

The rise of single stocks, the appeal of leveraged deals with no protection and the bid for interest rate products were the main trends seen for the year so far, the data showed.

As of June 8, sales at $392 million for the month were up 23% from the first eight days of May, which recorded $319 million issued, an encouraging sign for the early part of the month.

Volume was down by slightly less than 7% compared to last year as agents have so far sold $16.41 billion since the beginning of the year versus $17.61 billion during the same time last year.

"There is a pattern in the market. Usually volume is less active in May and June compared to the first months of the year," a structurer said.

More stocks

Single stock issuance is up 9% for the year while equity indexes have dropped 8.75% in volume. The market share of stock-linked notes has grown to 23% of the total from 20% last year, according to Prospect News. Meanwhile, the percentage of equity index deals out of the total volume has remained somewhat constant at 53%, compared with 54% last year.

"I guess you're seeing more stocks than before because people are trying to capture volatility where they can find it. Perhaps that's also why the issuance of equity index deals has declined a little," a sellsider said.

He noted that the trend was not visible everywhere, however.

"Issuance volume in single stocks may have increased in the market in general, but for some firms, it's the opposite that happened," he said.

"Volatility is low across the board, and it's true with single stocks as well.

"You get less from selling the options. The optical nature of reverse convertibles doesn't look very good."

The top stock deal of the week - and the No. 2 in size overall - was brought to market by Wells Fargo & Co., which priced $41.4 million of 0% optionally exchangeable securities due June 5, 2020 exchangeable for the common stock of Intel Corp.

Beginning July 12, each security is exchangeable at any time for 34.633 Intel shares. The issuer has the option to settle exchanges in Intel stock or cash.

The exchange ratio is equivalent to an exchange price of $28.87 per Intel share. Intel stock closed at $24.71 on the pricing date.

The notes are callable after five years at any time. The redemption price will be the greater of par and parity, which on any day is the exchange ratio multiplied by the closing share price.

The payout at maturity will be the greater of par and parity.

"The renewed interest in single stocks is not easy to analyze. Perhaps people are interested in more idiosyncratic bets on stocks," the structurer said.

"This [Wells Fargo] deal is kind of a convertible bond," he added.

"You can calculate how much the stock will have to increase to get par. If you divide par of $1,000 by the exchange ratio, you get $28.90. Divide that by the initial price of $24.71 and you find out that you need a 17% increase in order to break even. Considering that you're foregoing a dividend yield of 3.6% for Intel for the next seven years, you're not getting that much.

"You get capital guarantee with a rather small or low participation. I'm not sure why the deal was so popular."

CMS fashion

Rates deals have doubled this year but represented only 3.5% of the total.

"Interest rates deals are picking up because rates are moving up. People see value in those deals," the structurer noted.

"Long-term interest rates have been increasing rather fast.

"That's probably why people are making some bets on the flattening or the steepening of the curve.

"By playing the CMS curve, you can leverage your position according to your view."

The top interest rate-linked notes offering - and the No. 3 deal of the week - was Citigroup Inc.'s $25 million of callable leveraged CMS spread notes due June 11, 2033 linked to the 30-year Constant Maturity Swap rate and the five-year CMS rate.

Interest is 9.125% for the first year. After that, it is four times the spread of the 30-year CMS rate over the five-year CMS rate minus 25 basis points, up to a maximum interest rate of 9.125% per year. Interest is payable quarterly and cannot be less than zero. The payout at maturity is par. The notes are callable after two years.

"It's a play on steepening. It makes sense to me. It's a 20-year structure. If the 30-year interest rate increases faster than the five-year, you would get a higher coupon than what would be possible with a 20-year Citigroup coupon," he said, adding that a 20-year Citigroup bond currently offers a yield to maturity of 5.75%.

"The 30-year CMS rate is 3.21%, and the five-year is 1.3%. If you multiply by four the 1.91% spread, you're getting a 7.64% yield. The deal gets you a relatively high coupon. Now on the other hand, if the five-year increases more than the 30-year, you would get less, especially with the leverage. But you wouldn't get called. Issuers don't call unless they have to pay more if they don't.

"These notes are not callable for two years, which is a plus.

"Worst-case scenario, if you are not called, you're stuck with Citigroup's triple-B paper for 20 years. I don't know many people who would like to do that."

In a hybrid asset class involving rates and equity, another firm offered a CMS deal among last week's top products.

Morgan Stanley priced an upsized issue of fixed-to-floating-rate leveraged CMS curve and S&P 500 index-linked notes due June 7, 2028, adding $10 million of notes to the original size of $10 million.

The coupon is 9% for the first two years. Beginning on June 7, 2015, it is (a) four times the spread of the 30-year CMS rate over the five-year CMS rate multiplied by (b) the proportion of days on which the index's closing level is greater than or equal to 1,150. The interest rate is subject to a floor of zero and a cap of 9% per year. Interest is payable quarterly.

"You're probably going to see more CMS deals because interest rates are moving upward," the structurer said.

"It's not a good thing to stay in bonds because interest rates and bond prices move in opposite directions. Playing the curve movements without having a fixed coupon prevents the portfolio from losing too much money. It's an alternative.

"You're not solely depending on interest rates movements, you're depending on a combination of interest rates movements."

Commodities have seen the biggest decline so far this year. Their volume has fallen 33% from last year to represent only 5.5% of the total versus 8% last year, according to the data.

"The drop in commodities issuance is not a surprise. Commodities have performed rather badly. Nobody is interested in them," the structurer said.

No protection

In terms of structures, leveraged notes with full downside exposure remain the most popular product, up 26% in volume from last year. They make for 21.5% of the total versus 16% last year.

JPMorgan Chase & Co.'s $44.33 million of 0% capped return enhanced notes due June 25, 2014 linked to the MSCI EAFE index, the No. 1 deal last week, belonged to this product category, giving investors full exposure to the downside. On the upside, the notes offered two times leverage up to a 22.1% cap.

"The fact that there is an uptick in products that do not have downside protection implies that investors are more bullish and that they're not valuing principal protection the same way they used to," the sellsider said.

Coming after unprotected leveraged deals, autocallable reverse convertibles represented the second-most popular structure this year. The market share for these notes is now 17.25% of the total versus 8% last year, and their volume has nearly doubled, up 97% from last year.

The third top structure is leveraged notes with partial downside protection either through a barrier or a buffer. This product type represents 15.5% of the total this year versus 19% last year. Volume in this product type is down 24% from last year.

The top agent for the week was JPMorgan, pricing 12 deals totaling 20.82% of the total with $82 million. It was followed by Morgan Stanley and Goldman Sachs.

"People are trying to capture volatility where they can find it." - A sellsider

"Commodities have performed rather badly. Nobody is interested in them." - A structurer

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