Reverse convertibles highly bid last week; issuance down for month, but year is still up

By Emma Trincal

New York, March 20 - Market participants remain optimistic about the pace of issuance despite a slowdown for the month to date. Last week was marked by a strong bid for stock deals and reverse convertibles, according to data compiled by Prospect News.

Agents sold $369 million in the week ended Friday, a 6.55% decline from the prior week, which saw the pricing of $395 million.

More tellingly, the comparison between the first half of March (up to March 16) and the same period in February shows a 12% decline, with sales down to $1.01 billion from $1.15 billion.

Figures do not include certificates of deposit, unregistered notes and large plain-vanilla "structured coupon" fixed-income deals such as step-ups and fixed-to-floaters.

However, the year-to-date volume remains stronger than last year with $7.79 billion sold as of March 16, a 4.58% increase compared to the $7.45 billion sold during the same time last year.

Still, the year's advance is shrinking from previous weeks, according to the data. As the year nears the end of the first quarter, sources said that the end of March should be watched carefully for forecasting trends. For now, market participants remain hopeful.

Retail more upbeat

"We are optimistic that we are going to see issuance picking up as we continue through the year," a sellsider said.

"If the strong volume seen earlier this year is slowing down a little bit right now, it may just be a coincidence and not necessarily have anything to do with market factors."

Low interest rates and volatility, which work against the market in terms of pricing, may not be long-lasting conditions, according to this sellsider.

"There is no doubt that pricing conditions are not as attractive as in the beginning of 2011.

"But on the other hand, issuers are becoming more and more creative, and with those innovative structures, there's a new story to go out there with and tell the clients.

"Morgan Stanley, Credit Suisse and others have come up with these trigger notes that pay higher annualized coupons based on indexes, which provide a greater downside protection. Those structures resonate well with investors.

"As we go into 2013, we're likely to see a pickup in volatility. Products will become more attractive."

With the rally, investors have bought a greater proportion of equity-linked notes this year, the data showed.

Equity-linked products are up 13% from last year, representing nearly 80% of the total versus 73.5% last year.

Just last week, the concentration of products linked to equity assets was exceptionally high at 91% versus 82% the previous week.

"Equities are attractive right now as prices are rising. Retail investors are becoming much more optimistic in general," the sellsider said.

"The Dow is trading at all-times high as well as the S&P. Obviously we went through a rough couple of years, but investors are starting to get a clearer picture of some of the positive trends going on in the market right now. Europe still exists. The U.S. economy is starting to grow again. We're in a strong bull market. They're reading it on CNBC or Bloomberg, and it makes them more comfortable about putting their money to work.

"As the market continues to rebound and the economy continues to grow, investors increasingly want to be part of the action. It's not just going to be a general trend in the overall market. Structured products will be a big portion of it."

Fed wildcard

Some factors that may impact volume remain unanswered questions for the market, especially the timing for the Federal Reserve to end its quantitative easing program and start to raise rates.

"We may be at a crossroads as we get closer to the end of the first quarter," a structurer said. "So many factors can impact issuance volume. One that's very significant is this afternoon's Fed meeting."

The Fed was set to release the Federal Open Market Committee statement and the Summary of Economic Projections at 2 p.m. ET on Wednesday before press time.

"Is the Fed going to send a message that the economy is growing and that they'll stop keeping the rates low sooner than expected? If there's a shift for the exit from 2015 to 2014, that would be very significant for the market. The initial reaction would be disappointment, but then investors will realize that the economy is growing and the rally will come back very quickly," he said.

Other asset classes have not fared as well as equities, in particular commodities, which saw their volume decline by 36.5% for the year to $441 million from $695 million last year. For the week, volume in this asset class was down 16%.

"Commodities have been hammered due to concerns about China. China is a top commodities consumer, and demand from China has a strong impact on the commodities market," the structurer said.

"With economic growth slowing in China, commodities prices have been under pressure.

"A lot of the answers will come from the Chinese government and the policies they will be implementing. It will also determine what kind of commodities will be in demand. To be watched."

Reverse convertible rebirth

Last week's major asset class and structure trends were the spike in reverse convertibles and the strong appetite for deals linked to single stocks, according to the data.

Stock-linked notes grew by nearly 50% last week to $159 million from $107 million, with the number of deals increasing to 62 from 54.

At the same time, demand for equity index products declined by 18% to $176 million from $215 million.

The 43% percentage of single-stock deals out of the total was closer to that of equity index products at 47.5%.

Reverse convertible products - either in traditional format or with an autocallable feature - were the most sought-after structure. They more than doubled in volume to $178 million from $86 million and made for 48% of the total.

The trend is also true for the year to date, which saw a 32% growth, largely driven by the autocallable types of those products.

"What you're seeing is investors starving for yields out there," the sellsider said.

"Reverse convertibles allow you the opportunity to enhance your yield over that shorter period of time, six months to one year, versus what you can get in the marketplace with traditional fixed-income instruments or even high-yielding stock dividends.

"Pricing is a little bit better compared to the first two months of the year.

"In January and February, the VIX [index] was at all-times low, around the 12 range. Historically, 16 to 18 has represented a normal range for the VIX."

The VIX reached a peak at the end of February at 19. On Monday, it rose to 13.4.

"The uptick makes the products more attractive. But the main reason for the appeal of reverse convertibles is that investors are willing to take more risk as they are seeking yield."

Top deals

Six of the 10 deals in excess of $10 million were variations of reverse convertibles either non-callable or autocallable.

Royal Bank of Canada priced the No. 2 offering with $44.56 million of 8% coupon-bearing notes due March 28, 2014 linked to Chesapeake Energy Corp. shares. BofA Merrill Lynch was the agent.

The product offered a 7.1% buffer on the downside with a point-to-point payout.

The fourth-largest deal was an autocallable reverse convertible brought to market by Morgan Stanley. It priced $24.2 million of contingent income autocallable securities due March 21, 2016 with step-up redemption threshold level feature linked to the common stock of JPMorgan Chase & Co.

RBC's $20 million of contingent income autocallable securities due March 18, 2016 linked to the common stock of General Motors Co. featured 11 quarterly determination dates for the autocall triggered at or above the initial price. The contingent payment was paid at or above a trigger of 75% of the initial price. It was the No. 5 offering.

The sixth-largest offering was Citigroup Inc.'s $12.91 million of 10.25% Equity LinKed Securities due Sept. 19, 2013 linked to Facebook, Inc. shares with an 80% barrier.

Another big single-stock deal and the third-largest offering of the week, but in a separate structure type, was JPMorgan's $25 million of 7% equity-linked notes due March 10, 2014 linked to the common stock of American International Group, Inc.

The top agent last week was Goldman Sachs, which priced the top offering with its $50 million of 0% notes due Oct. 1, 2013 linked to the Topix index. Priced at 99.86, the tracker offered investors par plus the index return at maturity.

Goldman Sachs sold six deals totaling $72 million, or 19.61% of the market.

The second and third top agents were BofA Merrill Lynch and JPMorgan, respectively.

"If the strong volume seen earlier this year is slowing down a little bit right now, it may just be a coincidence." - A sellsider

"We may be at a crossroads as we get closer to the end of the first quarter." - A structurer

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