Issuance is up 72% month to date amid record high equity prices, post fiscal cliff relief

By Emma Trincal

New York, Jan. 16 - Issuance continued to be strong last week. The equity rally buoyed volume as investors flocked into callable notes and leveraged structures in a bid to seek more income or enhanced upside, sources said.

"The market has already seen the fiscal cliff deal and as a result, investors are a little bit less nervous about Washington getting things done. They're still nervous, but there's definitely a sense of relief," a market participant said.

The S&P 500 index last week reached a five-year high.

Equity funds, including mutual funds and exchange-traded funds, took in a whopping $18.3 billion in January as of Jan. 9, according to Lipper, which announced in a report that the inflow was the fourth largest net inflow into equity funds since January 1992.

"Money is flowing back into the market. We've seen high inflows in equity. Inflows have increased everywhere. There is a reason why the market is up," the market participant said.

Back in the game

Agents sold $340 million of structured notes in the week that began Jan. 6, a 43% decrease from the week of Dec. 30, which saw the pricing of $594 million, according to data compiled by Prospect News. However, part of the decline is due to the strong prior week during which many large deals overlapped with December.

A more telling comparison would be on a month to date basis, looking at Jan. 1 to Jan. 12 and the same period in December.

Issuance volume in that timeframe reached $913 million for the month, a 71.64% increase from $532 million sold during the same time last month, the Prospect News data showed.

January so far has picked up in momentum not so much in the number of deals - 138 this month versus 156 last month - but in their size. Agents priced 14 deals bigger than $20 million in size versus 12 during the same time in December.

For the year, sales have declined by 2.62% from $937 million during the first 12 days of January 2012, but it is too soon to draw any conclusions, sources said.

Phoenix rising

One main structural trend seen across different periods is the appeal of callable reverse convertibles, which some firms sometimes call "trigger phoenix autocallables," the data showed.

"The popularity of those structures is somewhat puzzling given the low volatility environment," a structurer said.

"You get conditionally protected, but you don't get as much value for the down-and-put that you're selling, so the terms are not all that attractive.

"Maybe it's a habit thing or the lack of alternatives in a zero-yield environment if you don't want to climb down the credit ladder when buying fixed income.

"At least if you are willing to go to stocks, you're getting a better yield. But there are better opportunities in structured notes, I think."

Those deals typically offer a contingent return when the underlying closes above a trigger price on a given observation date. If on the same dates, the underlying is above its initial price, the notes get called and investors receive their coupon. At maturity, investors are protected above the trigger but lose on a one-for-one basis from the initial price if the barrier is breached.

It was the structure used in the third-, fourth- and fifth-largest deals of the week, which were sold by UBS, JPMorgan and Morgan Stanley, respectively.

Deutsche Bank AG, London Branch priced $33.6 million of trigger phoenix autocallable optimization securities due Jan. 12, 2018 linked to the common stock of General Electric Co. The trigger price was 71.46% of the initial share price, based on a monthly observation date with an 8% contingent coupon. It was the third-largest deal.

The fourth was JPMorgan Chase & Co.'s $18.92 million of autocallable contingent interest notes due Jan. 29, 2014 linked to Occidental Petroleum Corp., with an annualized coupon of 12.25% and an 80% barrier.

Morgan Stanley priced the fifth deal in the same structure type with $15.90 million of contingent income autocallable securities due Jan. 16, 2015 linked to Caterpillar Inc. stock.

"As investors continue to chase income in a low interest rate environment, those products are becoming increasingly popular. These are simply the second generation of autocallables," the market participant said.

"With the first generation, the coupon was fixed. Only your principal was at risk. If the equity was below a threshold at maturity, you were losing some principal but your coupon was safe.

"With this second generation, you're not just risking your principal. You're putting your coupon at risk too. This is how you're getting a higher coupon of course, and that's why this type of structure has become more popular.

"To me it is also another form of leverage because as long as the underlying is above the trigger price, you are getting the coupon, which is a form of enhanced return.

"People are embracing leverage on a broader acceptation of the term," he said.

Those hybrid autocallable notes have grown by nearly four-fold since last year. They make for 16% of the year-to-date total with $146 million versus $40 million last year. Their volume nearly tripled from the same period last month, which saw the pricing of $43 million in this category.

Leverage

"We're seeing a strong demand for leveraged notes with no downside protection, meaning no buffer or barrier," the market participant said.

"Investors realize that leverage through structured notes is more efficient. It's a more cost-efficient alternative to borrowing on margin for instance.

"To the extent that there's a rally and that investors want to get exposure to the market, you're going to see an increase in leverage. But I wouldn't read too much into it.

"The trends of buying leveraged notes without downside protection started before the New Year. We've seen it since the fourth quarter of 2012.

"It's not so much that investors have become more bullish. It's more that they believe they can add value in buying leveraged notes without downside protection. They can get higher caps or more leverage, so they're going to do it."

Leveraged notes with no downside protection also have gained momentum so far this year.

Their volume amounted to $303 million, a 70% increase from last year. In market share, the product so far this year represented a third of total issuance versus 19% during the same time last year.

On a month-to-date basis, leveraged notes with no barrier or buffer are up 145% from the same period in December.

Stocks, FX

Stock picking seems to be in favor again, according to the data. Single-stock-linked notes grew to $204 million this month from $135 million during the same time in December. For the year to date, the asset class volume is up 24% from Jan. 1 to Jan. 12 of last year.

During that time, the growth in stock deals was accompanied by an 18.5% decline in equity index issuance, according to the data.

Sizes for single-stock offerings vary. Most of the top deals are in the form of trigger phoenix types of products while a myriad of little deals are merely traditional reverse convertibles.

UBS sold 50% of all the stock deals last week.

Currency-linked notes grew strongly last week to $69 million, or 20% of the total, from $11 million the week before. This was due to HSBC USA Inc. pricing the top offering of the week, its $40 million of 0% knock-out buffer notes due Jan. 28, 2014 linked to the Mexican peso relative to the dollar. The notes offered a 6.4% contingent return and a 90% barrier. JPMorgan was the agent.

The structurer said that he was surprised that investors would bid on this asset class.

"We haven't seen people in FX notes simply because they don't understand it," he said.

"We've been trying to push currency deals like currency baskets and nobody knows what to do with them. What we're seeing instead are currency option trades.

"The euro is currently trading at 1.326 against the dollar. You can sell a call on the euro with a 1.33 strike. You get compensated 5% for the next month, on 0.41% for the month."

A large deal increased the volume seen for commodity-linked notes last week to $50 million, or 15% of the total, in three deals.

Deutsche Bank priced $39.5 million of securities due Feb. 13, 2014 linked to the Dow Jones - UBS Commodity Index Total Return. The structure was callable and putable and had a three-times leverage factor. Morgan Stanley was the agent.

UBS was the top agent last week with $86 million in 42 deals, or 25.35% of the total. It was followed by JPMorgan and Deutsche Bank.

"They're still nervous, but there's definitely a sense of relief." - A market participant on investor sentiment following the fiscal cliff deal

"But there are better opportunities in structured notes [than callable reverse convertibles], I think." - A structurer

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