Issuance grows by 128% last week; equity retreats, yet single-stock deals dominate with bank names

By Emma Trincal

New York, June 30 - An increase in non-equity offerings, essentially commodities and rates products, and a prevalence of single-stock underlyings within the equity asset class were the two main U.S. structured products issuance themes for the week ended Friday.

Agents sold $1.14 billion in 273 deals, a 128% increase in volume. The number of deals was up by more than three times.

As volatility and uncertainty rose amid a sell-off, investors either fled U.S. stocks or made bets on selected names, especially in the financial sector, in an attempt to capitalize on volatility spikes, sources said.

Volatility as measured by the Chicago Board Options Exchange Volatility index rose 15% last week while the S&P 500 declined by 3.32%.

"The stock market has taken a more bearish turn. With the uncertainty, people want diversification," a New York sellsider said.

More deals

Structured products issuance rose sharply during the week, a typical month-end trend, but the bulk of the growth was driven by the multiplication of the number of deals rather than by an increase in their size, data compiled by Prospect News revealed.

Despite the increased volume, the average deal size shrank to $4.1 million from $5.8 million the week before, according to Prospect News data.

Some saw in this a sign that the rise in volatility may have made some deals harder to price.

"With volatility up, you have cancellations. When dealers can't upsize, they close smaller deals," the sellsider said.

However, selling more deals toward the end of the month is also a persistent pattern, a market participant noted.

The number of deals priced between the third and fourth weeks of any month has increased by a factor varying between three and six times this year, according to data compiled by Prospect News.

"We're coming up on July 4, and even though it's on a Sunday, people still get on the holiday mode," the market participant said.

"Issuers, sales managers have already pushed sales last week. We could be losing two weeks because of July 5."

For some, small deals are the signature of internal distribution patterns.

"More and more small deals get distributed internally via private banking distribution channels," the sellsider said. "Firms push their own deals as part of an asset allocation recommendation."

Less equity, yet more stocks

Deals linked to equity declined to 66% from 76% the week before.

But within equity, single-stock transactions - essentially reverse convertibles - made a big push to 34% of issuance from 24%, according to data compiled by Prospect News.

Meanwhile, equity-index-linked products pulled back to 32% from 51%.

"Single-stock deals appetite is a case of investors trying to call the bottom," said Brad Livingston, a distributor at Laidlaw & Co.'s Income Solutions Group.

Demand for single-stock products coincided with a strong bid for reverse convertible products, a type of structure that fits the needs of investors when the future direction of the market is uncertain, he said.

"Reverse convertibles are designed for moderate to neutral outlook," Livingston said.

"You can be moderately bullish or moderately bearish as long as you don't think the stock can go down more than the threshold and go up more than the coupon. It's a great way to get that high coupon for the short term."

Bank of America Corp. priced the top deal with a $91.4 million issue of 9% STEP Income Securities due July 8, 2011 linked to the common stock of General Electric Co.

In addition to the coupon, the structure offers a possible 2.4% extra return if the final share price of GE stock is greater than or equal to the step level, which is 109% of the initial share price. There is a 5% barrier on the downside.

Financials top

Issuers successfully priced large offerings linked to financial stocks, with four out of the five biggest deals tied to bank names.

"Uncertainty around the financial reform fueled volatility. It means higher coupons, better pricing," the New York sellsider said.

Morgan Stanley priced the No. 2 deal with $84 million of 9% annualized Equity LinKed Securities due Dec. 27, 2010 based on JPMorgan Chase & Co. with a 25% downside threshold.

UBS AG, London Branch sold the fourth-largest transaction with a $58.2 million offering of 10.58% yield optimization notes with contingent protection due June 29, 2011 linked to the common stock of JPMorgan Chase.

Finally Bank of America priced $40.04 million of 11% STEP Income Securities due July 7, 2011 linked to the common stock of Citigroup Inc. There is a potential extra return of 3.21% if the share price of Citigroup hits the step level at 111% of the initial share price. The threshold value is 90% of the initial share price.

The popularity of bank stocks was attributed to the expectation for a possible rebound in the sector as some stocks have already incurred heavy losses.

For example, the New York sellsider noted that JPMorgan shares are down more than 11% this year.

"Financials are strengthening despite the uncertainty. The view is that banks shouldn't go down significantly more than they already have," Livingston said.

"You always want to be ahead of the game rather than behind," he said. "While there's no real high upside outlook for financials, getting 11% on a recovery name is very attractive."

The void left by the reduced volume of equity-linked notes was filled mostly with commodity-linked transactions and to a lesser degree by rates-linked products, according to data compiled by Prospect News.

Another place to go

Commodities-linked notes represented 15% of the total sold last week, versus 3.5% the week before, a significant increase based on a declining pattern seen over the past few months.

Most of the deals were plain vanilla notes linked to a broad commodity index as opposed to notes giving a hybrid exposure to the asset class in a reverse convertible format as seen in prior weeks.

Although fears of a global growth slowdown have hurt commodity prices, investors were drawn to the asset class as a hedge against downside risk and a diversifying tool from equity, sources said.

"When the outlook is negative, people want a different place to go. Commodities are that different place. It's a non-correlated asset. It's an avenue for both bulls and bears," said Livingston.

Agents priced five commodities-linked deals that had a size in excess of $10 million, a sign that interest in the asset class was picking up, sources said.

"Commodity deals were due for a rebound as you had nothing for a while," said the sellsider. "But those deals center on gold and oil. It's a volatility play on oil, an inflation hedge with gold."

Gold rush

The biggest commodity offering last week was also the third-largest deal: Bank of America's $77.58 million of 0% Market Index Target-Term Securities due June 30, 2015 based on the spot price of gold. The payout at maturity is linked to the precious metal price with a 70% cap. The notes are principal-protected.

"This is good if you think gold will still be up in five years but not so good if you believe the stock market will turn around," said Livingston.

"The gold rush is overdone. This $77 million note on gold is risky despite the principal protection. You can have your money locked in for five years with zero return since you're buying gold at its peak," the sellsider said.

Other asset classes

Interest rates products also benefited from the equity pullback, rising to 8% of the issuance from 2.2% the week before.

Fourteen deals priced in this asset class against two deals during the prior week.

One notable rate transaction was Bank of America's $17.6 million issue of callable capped notes due July 1, 2022 linked to the 30-year and two-year Constant Maturity Swap rates.

"As the market anticipates a rise in interest rates, swap deals continue to be attractive, especially with leverage," said the sellsider. "Some of the issuers also have very advantageous funding costs."

Currencies continued to be the least-favored asset class with only 3% of the total volume in five deals, compared with 5.6% the week before.

The biggest transaction in this category was UBS AG, Jersey Branch's $9.64 million issue of performance securities due June 28, 2013 linked to the UBS V10 Currency Index with Volatility Cap.

Leverage tops, Merrill leads

Leveraged notes were the top structure of the week with a third of total issuance in 59 deals, on par with the prior week. Reverse convertibles followed with 22% of the total in 155 deals, up from representing only 13.5% of the previous week's issuance.

Merrill Lynch remained No. 1 with $533 million sold in 24 deals, accounting for nearly 47% of the total.

It was followed by Morgan Stanley, which priced $147 million in only five deals for 13% of the total.

The third agent was UBS, which sold nearly 12% of the total issuance with $133 million in 17 deals.

"With volatility up, you have cancellations. When dealers can't upsize, they close smaller deals." - A New York sellsider

"When the outlook is negative, people want a different place to go. Commodities are that different place. It's a non-correlated asset." - Brad Livingston, a distributor at Laidlaw & Co.'s Income Solutions Group

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