Big Euro rate deal, spike in bond volatility boost May volume; appetite for rates on the rise

By Emma Trincal

New York, May 20 – Agents sold $601 million in the week ended Friday in 112 deals. Volume was buoyed by Barclays Bank plc’s $142.17 million of five-year 0% leveraged 30-year Euro Constant Maturity Swap rate-linked notes, which offered 10 times the difference between the final rate and the initial rate along with 90% principal protection.

At $1.23 billion, the monthly volume looks healthy so far, up nearly 54% from April and 47% from a year ago as of May 15, according to data compiled by Prospect News.

Sources attributed the large size of the Barclays offering as well as the robust volume to the recent global bond volatility, which sparked a rise in interest rates, especially in Europe.

Bond volatility and pricing

“We’re definitely seeing a lot of deals. Notionals have expanded tremendously too. For us it’s more the number of deals, but our notional is in the upper medium,” a structurer said.

“The bond sell-off helped volume in general. Equities are at an all-time high. Volatility is at the bottom quartile.

“Higher yields have a positive impact on the pricing of the bond component. I think the rate sell-off was beneficial, providing better economics. It’s particularly helpful for principal-protected notes and CDs.”

The market reaching new highs was also very positive, he noted.

“It helps the deal flow. It’s easier to pick up the phone and talk to someone who missed the rally or who is concerned about protection. It’s an easy pitch.”

A market participant said that the size of the Barclays offering may suggest a shift in investor appetite for the rates asset class.

“We haven’t seen a lot of volume or deals in rates so far this year, but things are changing. We’re seeing more interest. We may be at a turning point,” he said.

More rates

“The global theme for years has been the bond rally with interest rates coming down. People have gotten used to the idea that bonds are safe and that they generate attractive returns. But those expectations are changing as the market now anticipates that rates are likely to go up,” he said.

“The question becomes, how do we position ourselves?”

While some investors buy equity-linked notes to diversify away from bonds, bond investors are seeking to protect their bond portfolios rather than cut them, he explained.

“They just want to hedge interest rate risk. That’s why some notes like the Barclays are interesting,” he said.

U.S. firms rarely use Euro bond rates as the underlying of their notes, preferring Treasuries CMS rates, according to the data.

“They did it just to be cool and different,” he joked.

“Europe has attracted attention in general because it is moving toward higher rates. Maybe the view is that since rates are lower in Europe than in the U.S., they expect a bigger bounce. That’s where they see the next opportunity. They see equity in Europe rallying. If Europe does well economically, yield will go up.

“They now have QE in place. Maybe short term it’s depressing rates, but five years from now, they see that rates will go to their natural level.

“I think rate deals are becoming more prevalent. I think it’s likely to continue going forward.”

U.S. Treasuries sold off in reaction to global bond market volatility two weeks ago, and some analysts believe that any further rise in yield is likely to be modest, at least for now.

On Monday, the European Central Bank announced a ramp-up of its QE program to alleviate low liquidity in the summer.

“The trend in higher yield is likely over for a bit until we head closer to September with the probability of a rate hike,” a market strategist at a sellside firm said.

The top agent last week, not surprisingly, was Barclays with a third of the volume priced in 11 deals totaling $197 million, according to the data.

Behind Barclays, Bank of America claimed the second slot with $128 million in four offerings, or 21.25% of the volume.

Other top deals

Typically, Bank of America’s presence in the market in the early or mid-part of the month is modest as it prints almost all of its offerings in the final week of the month, dwarfing its competitors with sometimes up to a third of the volume in that period, according to the data.

Bank of America was the agent for the second largest deal of the week, Deutsche Bank AG, London Branch’s $52.61 million of 0% autocallable market-linked step-up notes due May 25, 2018 tied to the Euro Stoxx 50 index. The notes offered a 12.65% call premium based on an annual call observation date and a call trigger at or above the initial index level.

If the index finished at or above the initial level, the payout at maturity would be par of $10 plus the greater of the gain and the 35% step-up payment. Investors were fully exposed to any losses.

Bank of America also distributed the No. 3 offering, which was also brought to market by Deutsche Bank. It used the same structure with different terms. The six-year product was linked to the S&P 500 index. It offered a 6% a year call premium and a step-up payment of 30%. One difference was the existence of a 15.5% buffer.

“These could be a one-off offering for one or two clients,” the market participant said.

“If there is demand, they have to move fast. That would be my guess.”

Barclays’ $24.99 million of 9% STEP Income Securities due May 31, 2016 linked to Southwestern Energy Co. shares was the No. 4 deal of the week. Bank of America was also the agent.

If the shares finished above the step level, 109% of the initial price, investors received an additional income payment of 5.81%. Investors were exposed to any losses.

“Historically, the bulk of structured products are those designed to generate opportunities for predictable income,” the market participant said, commenting on this STEP Income structure commonly sold by Bank of America to its clients.

“In the past, reverse convertibles were popular, but the market has moved away from it. Instead some new ideas that offer income have emerged, and this is one example. There will always be room for income-oriented products.”

Bank of America

For this market participant, the strong participation of Bank of America in last week’s action was probably not indicative of a shift in their regular timetable.

“Because their products are popular within their system and they have very large clients, you’re going to have some one-off deals raising the notional volume at certain periods. That would be my guess,” he said.

“But their machinery is still geared toward end-of-the-month pricing. Unless you see a repeated pattern of volume spike in the middle of the month, I doubt that they changed their issuance cycle in the calendar. It’s really a monthly cycle.

“It takes time to get together a calendar, to identify themes, to get the docs ready and give advisers time to market it.

“Because of that, the traditional schedule, once a month, seems to work well within a large warehouse.”

“They did it just to be cool and different.” – A market participant joking about Barclays’ use of a Euro CMS rate

“The trend in higher yield is likely over for a bit.” – A market strategist at a sellside firm

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.