Rates deals make for nearly third of volume amid Fed buzz during otherwise quiet week

By Emma Trincal

New York, July 17 - Issuance last week recorded the slowest weekly pace for the year at $166 million sold in 60 deals. It was a nearly 5% decline from the already tepid holiday week that preceded it, during which issuers priced 64 offerings totaling $175 million, according to data compiled by Prospect News.

More unusual was the proportion of the volume that was linked to rates - 30% of the total in three deals totaling $49 million. They were bets on the steepening of the swap curve.

Interest rates rose sharply early last week after the market worried about the potential tapering of the Fed's quantitative easing program, but fears dissipated after chairman Ben Bernanke's dovish comments on Wednesday, leading the S&P 500 index to its highest closing ever on Thursday at 1,675. The benchmark has continued to rally since then, reaching 1,682 in mid-session Wednesday.

No entry point

"The market has gone up a lot," a market participant said.

"If you watch CNBC, every single day the market hits record highs. The investors we're speaking with still want to be in the market, but they're waiting to see if the prices can go a little lower.

"There's a strong demand for non-equity products likes steepeners. Trades contingent on equity performance, we still see demand for it but there's more hesitation, and that's causing a little bit of a pullback. It's a very aggressive uptick."

Volume for the month up to July 13 is down nearly 50% from the same period in June. Sales have fallen to $341 million from $671 million.

Sources said that the first half of any given month is rarely conclusive.

The biggest week of the year so far was the last week of June totaling $1.85 billion, or nearly 10% of the yearly volume, according to the data.

Volatility coming up

For the year, volume is $19.46 billion, a 2.80% decline from last year.

"This is not a really significant decline," the market participant said.

"Usually July is slow, but August tends to get busy. I don't think July was that slow. We had a unique holiday week with July Fourth falling on a Thursday and a lot of people taking Friday off.

"From what I understand, people are still ticketing their deals. It's too early to write off July.

"I believe August will be a good month. A lot of things are going to happen in Europe, in particular the German elections. Over the past four years, August and September have always been very volatile. And you still have the Greek issue in Europe or the debt ceiling debate in the U.S.

"These are the times when interest in the products picks up, when demand for protection picks up."

CMS steepeners

The largest and the third largest deals last week were steepeners linked to Constant Maturity Swap rates.

Bank of America Corp. priced the largest one, its $33.25 million of capped notes due July 11, 2033 linked to the 30-year CMS rate and the two-year CMS rate.

The initial interest rate is 10.25%. After a year, the interest rate is four times the spread (the difference between the 30-year CMS rate and the two-year CMS rate minus 10 basis points) subject to a maximum rate of 10.25% per year and a minimum rate of zero. Interest is payable quarterly. Principal is fully protected.

Separately, Morgan Stanley priced $12 million of fixed-to-floating-rate leveraged CMS curve-linked notes due July 31, 2028. It was an add-on that brought the total deal size to $13 million from $1 million.

The coupon is 10% for the first year. After that, it will be 4.5 times the spread of the 30-year CMS rate over the five-year CMS rate, up to a maximum rate of 10%. Interest is payable monthly. The payout at maturity will be par.

Last week's bond sell-off was a factor behind those deals, sources said.

"CMS products have been around for a long time. It really has proven to have liquidity in secondaries. The good thing is that they're longer dated," the market participant said.

"If you only had one or two issuers, people would run out of room. But we're seeing more issuers participating in this market. Bank of Nova Scotia has done one with Incapital. Natixis has also jumped in, doing a non-registered deal. New entrants in this market have helped liquidity a lot."

Barclays sold a steepener deal on the behalf of Lloyds TSB Bank plc in its $3 million of callable capped CMS steepener notes due July 26, 2033. The first-year coupon is 11.15% followed by 4.5 times the spread of the 30-year CMS rate over the five-year CMS rate, subject to a maximum rate of 11.15% per year.

Interest rates-linked notes exceeded notes linked to single stocks in percentage of the total last week with stocks representing 24% of the volume. While equity-linked notes remained the No. 1 asset class with 38.5% of the market, their volume dropped by 4% while rates issuance grew by 40% from the week before.

The same growth trend applied to the monthly figure with rates products growing 111% from the previous month to $85 million, which represented nearly a quarter of the total market. In comparison, stocks made for less than 20% and equity indexes, 38%. Both equity asset classes were down significantly from the previous month by 62% for stocks and 55% for indexes, according to the data.

For the year, while rates volume remained small (less than 4% of the total), this category was the fastest-growing one, up 154%. Stock baskets saw their volume increase by 59% and single stocks, up 10.5%.

"There's definitely more interest in rates recently," a structurer said. "Natixis has started in this market. It's a new one.

"With rates rising, structures have become more attractive. We've seen more of those deals. It's a function of the pricing. But rates are coming back, making it harder again to do those deals. Maybe we'll see a pullback. I'm not sure."

The market participant explained that pricing conditions remained good because longer rates on a forward basis do not move as much as the short end of the curve.

"The forward shape of the curve is still very conducive for these kinds of deals. We're still in very good shape for these types of trades," he said.

A structurer noted: "The long-term rate is less influenced by the Fed. So the 30-year is not moving that much in the futures while the two-years is rising more. That's good for pricing," he said.

Yearly trends

Trends for the year continued to see equity barely up by less than 1% due to a 3.82% decline in equity indexes offsetting the 10.5% growth in single-stock deals issuance.

In market shares, notes tied to single stocks account for 22.6% of the total versus 54.5% for equity indexes, according to the data.

Autocallable reverse convertibles are the fastest-growing structure, up 91% and making for 16.85% of the year-to-date total. Leveraged notes with no downside protection remained the most popular category with a 20.75% market share. Their size has increased by 31% since last year.

Leveraged notes with buffers or barriers are down nearly 15% from last year, making for 17.3% of the total, compared with almost 20% last year.

Notes offering full principal protection have almost vanished from the market, down 93% to $32 million, or 0.17% of the total, compared with 2.26% last year, according to the data.

Goldman Sachs Group, Inc. priced the second-largest deal of the week with its $13.8 million of 0% leveraged index-linked notes due July 16, 2015 tied to the S&P 500 index. It was a non-protected leveraged note with a two-times leverage factor and a 31% cap.

UBS was the top agent last week pricing 38 deals totaling $34 million, or 30% of the market. It was followed by Bank of America and Goldman Sachs.

"I believe August will be a good month." - A market participant

"There's definitely more interest in rates recently." - A structurer

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