Growth in volume slows to 8.5% for year; BofA Merrill Lynch deals, uncapped payouts prevail

By Emma Trincal

New York, July 2 – The year-over-year increase in volume is decelerating as summer begins, according to data compiled by Prospect News, leading some sources to worry a little – although it is probably too soon to tell.

Agents in the first half of the year sold $20.88 billion, an 8.5% increase over the $19.25 billion priced during the same time last year.

While the increase is welcome, the pace of growth for the year to date is slowing down compared to periods seen earlier this year. For instance, at the end of April, volume on a year-to-date basis was up by more than 17%, the data showed.

Last week closed the month of June with $1.12 billion in 247 deals. For a month-end weekly period, this volume was below average. For instance, agents priced $2 billion in the last week of January and $1.88 billion at the end of February. They sold $1.9 billion at the close of May and $1.55 billion in the last week of March, according to the data.

“It’s been slow across the board for us this year,” a market participant said.

“Now that we’re in the summer, we’re a little bit nervous. I hope it’s not going to be too slow. Unfortunately, it usually is during that season.”

BofA Merrill Lynch had a strong lead last week as it always prices the bulk of its business at the end of each month.

BofA Merrill Lynch’s $455 million of sales last week represented 41% of the overall market, which was less than a month before when this agent priced 57% of the market in the last week of May.

The slight pullback may be due to incomplete data since last week did not take into account Monday, the last day of the month. Or it may signal a stronger push on the part of the rest of the market, which last week contributed 60% of the business versus 43% at the close of May.

Commenting on the overall market trend for the year, a sellsider said, “We’re still ahead of last year, but we’re just losing some ground. Sometimes a few days or a couple of big offerings will make a difference, so there’s no need to panic just because we’re up 8% versus 13% two months ago. We’re giving up some momentum, but hopefully it will stabilize. If at the end of July we’re up only 5% year over year, then we may have to be concerned about a slowdown. The year is not over, and we’re in the summer. We may bounce back.”

Penalty kicks

The World Cup may be a distraction for some traders, particularly at European firms, he said.

“It’s the soccer fever. Everybody was watching the U.S. being defeated by Belgium [on Tuesday]. The Europeans are watching. They’re completely into it. You can’t even get a price from a European trader. When they’re watching the penalty kicks, forget about it. We’ve asked French or German traders for price, and they’ve told us ‘go away, go away.’ Everybody is watching the World Cup,” he said.

“On top of that, summer is always slow.”

The slowest month of last year was April, followed by December, according to the date. July and June were the third and fourth slowest months, respectively. August surprised many as it turned out to be the third best month of the year after January and May.

“Look, I wouldn’t worry at this point. People are going away for vacations. It’s very hot weather. The U.S. has played and lost. Let’s see what happens,” he said.

Top 12 deals

The top 12 deals were sold by BofA Merrill Lynch except one – Wells Fargo & Co.’s$40 million equity-linked securities tied to Micron Technology, Inc., which was the No. 5 deal in size.

All of BofA Merrill Lynch’s top deals were market-linked step-ups or leveraged deals, the majority of which had no cap on the upside and no downside protection.

“Unlimited capital appreciation is getting more important these days,” the sellsider said.

“You still see caps of course, but we’re getting more and more requests for uncapped notes. The bull market that doesn’t end leads people to play the momentum. Who wants to be capped if the S&P keeps on reaching new highs? People are getting more familiar with the economics of a deal. They know they are not getting any coupon or dividend. The reasoning goes, if I’m being capped, is it reasonable not to get any coupon? Wouldn’t I be better off buying a bond for the yield or a stock for the dividends?”

Market-linked step-ups brought to market by BofA Merrill Lynch offered a good example of uncapped structures, which may only limit the upside if the product includes an autocallable feature, he said.

Autocallable step-ups

The largest offering was Bank of America Corp.’s $58.36 million of 0% autocallable market-linked step-up notes due June 23, 2017 linked to the Euro Stoxx 50 index.

The notes are automatically called if the index closes at or above its initial index level on either of two observation dates. The call premium is 10.5% after the first year and 21% on the second call date after two years.

If the notes are not called and the final index level is greater than the step-up value, 133% of the initial level, then the payout at maturity will be par plus the index return.

If the final index level is greater than or equal to the initial level but less than or equal to the step-up value, then the payout will be par plus 33%.

If the final index level is less than the initial index level, investors have one-to-one exposure to the decline.

“It’s a big size, and it’s not surprising. This structure is very popular,” the sellsider said.

“Getting uncapped return is very valuable,” the market participant said.

BofA Merrill Lynch sold on the behalf of another issuer the No. 6 deal in size using the same format.

It was Credit Suisse AG, London Branch’s $35.29 million of 0% autocallable market-linked step-up notes due June 30, 2017 linked to the MSCI Emerging Markets index.

The annual call premium is 10% based on annual call dates and the same threshold. The step-up value is 125%. The payout is similar.

Caps and volatility

“Those jump securities have been around for a while, but they’re getting increasingly popular,” the market participant said.

Whether one calls them “jump” or “step-up,” those payouts combining a digital return with unlimited upside make sense from a pricing standpoint, he noted.

“Volatility is so low, there’s no monetization of a call you’re selling right now. If vol was higher, you would need to sell something to offset the cost of the call. But since the options are so cheap and you’re hardly getting any premium, you don’t really need to sell anything,” he said.

He was referring to the sale of a call option, whose premium is usually used to lower the cost of purchasing the calls used for the upside participation.

Because volatility is low, structurers are not getting a rich premium when selling calls. In addition, buying the calls is cheaper. Both factors make the economics of a cap (the strike price for the short call) less necessary, he explained.

Some of last week’s step-up deals were not autocallables, such as HSBC USA Inc.’s $29.22 million of 0% market-linked step-up notes due June 24, 2016 linked to the S&P 500 index. The step-up value is 109.55% of the initial level. The maturity payout structure is the same. It was the seventh largest offering.

Leverage with or without cap

Leverage was the second top selling structure offered by BofA Merrill Lynch last week. The most popular among those deals were longer-dated uncapped leveraged buffered notes.

The No. 2 deal of the week was notable for its uncapped upside and the size of its buffer. It was Royal Bank of Canada’s $55.21 million of 0% Leveraged Index Return Notes due June 28, 2019 linked to the Dow Jones industrial average, which offers a 111.3% participation rate on the upside and a 20% buffer on the downside.

RBC sold nearly the same deal for $41.06 million. The maturity date, underlier and buffer are the same. The only difference is the 145.5% participation rate. It was the No. 4 offering for the week.

As the sellsider noted, caps did not completely disappear. BofA Merrill Lynch maintained them when it offered high leverage over a short maturity.

The No. 3 deal offered an example. Bank of America priced $47.04 million of 0% Accelerated Return Notes due Aug. 28, 2015 linked to the S&P Oil & Gas Exploration and Production Select Industry index. The upside participation rate is 300% up to a 15.84% cap. Investors are fully exposed to losses.

Equity mania

Equity index notes made for 63% of last week’s volume versus 19% for single stocks and 3% for equity exchange-traded funds.

One large stock deal was Wells Fargo’s $40 million of 8% equity-linked securities due June 18, 2015 linked to the common stock of Micron Technology, based on a convertible payout.

Equity volume this year is reaching record high levels with 82.5% of the total volume for the year to date versus 78.5% last year, according to the data.

This high percentage is due to the bull market, said the sellsider.

Indeed, over the entire year of 2013, equity products accounted for 80% of the total. The market share was 77.5% in 2012. It was lower in 2011 and 2010 at 67.5% and 64%, respectively.

“With the S&P 500 continuously reaching new highs, it’s understandable that people would pile into equity products. The market may be overpriced, overbought, some may say. But meanwhile, the trend is your friend. The market is up. Why fight the market?” the sellsider said.

Bid on Europe

Investors continued to show a strong appetite for deals linked to international equity indexes.

“The U.S. public has gotten used to buying global equity. Going offshore is no longer such a big deal,” the market participant said.

“Also, the Euro Stoxx volatility is cheap relative to the U.S. Anything with lower volatility is good if you’re buying optionality.”

Last week’s first and fourth largest deals were linked to the Euro Stoxx 50. Three offerings in the $20 million size were priced on the MSCI EAFE index. In addition, the sixth largest deal offered exposure to emerging markets.

“I think the most popular non-U.S. index by far is the Euro Stoxx right now,” the sellsider said.

“People are bullish on this asset class, and the mechanics of pricing are favorable because the index pays generous dividends., so it’s very popular.”

Yield

Investors continued to look for yield. Volume in interest rate notes has grown 55% this year to $1.16 billion, even though rates issuance makes for less than 6% of the overall market.

Investors, however, look for yield in some equity structures. A popular one is the Step Income note, another BofA Merrill Lynch’s best-selling products.

HSBC last week priced $25.4 million of 8% STEP Income Securities due July 13, 2015 linked to Masco Corp. stock.

The structure is similar to a market-linked step-up. The difference is that when the step level is reached, investors receive an extra coupon instead of the upside participation in the share price.

In this deal, the step-level is 108% of the initial price. Above this level, the payout at maturity will be an additional 4.45% bonus. If the stock finishes between par and the step level, the payout is par. Investors lose 1% for every 1% decline in the stock. The deal, sold by BofA Merrill Lynch, was the No. 8 offering in size last week.

The second agent after BofA Merrill Lynch last week was UBS with $219 million in 83 deals, or 19.6% of the total. It was followed by Barclays, which priced 16 offerings totaling $79 million, or 7% of the total.

“Everybody is watching the World Cup.” – A sellsider

“The U.S. public has gotten used to buying global equity.” – A market participant

© 2015 Prospect News.
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