With two big ETNs, volume surges to $1.98 billion, but holiday week seen slow for other deals

By Emma Trincal

New York, Oct. 20 - Columbus Day put the brakes on the four-day week ended Friday, which was marked by reduced issuance of traditional structured notes and a spike in exchange-traded notes deals.

October has been a good month for stocks, leading investors to continue to accumulate equity-linked notes. But the two top deals of the week - both ETNs - indicated investors' need to hedge returns via volatility and energy, sources said.

Including ETN volume - which was over $1.5 billion - issuance during the week ended Friday totaled $1.98 billion in 75 deals, according to data compiled by Prospect News.

It was much more than the $464 million sold in 64 deals in the prior week.

But without ETN sales, issuance fell to $340 million, down 27% from the week before.

Meanwhile, the average deal size for the ex-ETN issuance dropped by more than one-third to $4.65 million from $7.25 million.

"It was the middle of the month. That's partly the driver of it," a New York sellsider said.

"It was a slow week due to Columbus Day. Some deals priced on the 11th because equity is open. But there was not much selling. Advisers stayed home."

Equities-linked issuance increased in absolute terms to $397 million from $273 million. But this figure includes an ETN issued by JPMorgan Chase & Co. linked to the Alerian MLP index. This benchmark is composed of master limited partnerships, which are considered equity even though investors are using them as a play on commodities through the energy sector.

Equity driven

"Equity had a very nice return. October was great until the last couple of days. Investors are comfortable taking equity risk," the sellsider said.

"In this earnings season, two out of three companies are beating their forecast.

"Equity issuance will have a record year this year."

Equity index-linked deals regained their edge compared to the prior week when they showed a decline. Last week's growth was 46%.

Stock-linked deals grew as well, although the number of larger stock deals, those that exceed $10 million, was limited to two. Merrill Lynch priced the biggest one: $42.27 million of 8% STEP Income Securities linked to Boeing Co. common stock sold for AB Svensk Exportkredit.

Two big ETNs

But the week's main theme was the appeal of ETN products, which continued to sell well, sources said, commenting on two big ETNs add-ons from Barclays Bank plc and JPMorgan, which topped the list of deals.

Barclays added $1.5 billion of its iPath S&P 500 VIX Short-Term Futures ETNs, taking the total amount of this product listed on the NYSE Arca under the symbol "VXX" and launched in January 2009 to $16 billion.

"Those ETNs serve a very useful purpose," a second sellsider said. "They allow investors to make money if implied volatility goes up.

"Since there is a very high negative correlation between volatility and equity, the VIX ETN is a good hedging tool."

The second large ETN came from JPMorgan, which priced an additional $142.77 million of its ETNs linked to the Alerian MLP index.

This product, which debuted in April 2009, has also been a best-seller, with last week's proceeds propelling the total issue size to $1.05 billion.

ETNs represented not just the biggest deals but the most popular structure of the week with a total of four transactions.

However, the two others were much smaller in size. Credit Suisse AG, Nassau Branch priced two add-ons to its ETNs linked to the Cushing 30 MLP index, both of which were sized at $2 million.

Commodities as an asset class retreated to $48 million, down from $56 million. However, this result is skewed as mentioned above since the figure does not take into account the big Alerian MLP index-linked ETN, a play on the energy sector, nor the Cushing 30 MLP index.

Citigroup Funding Inc. priced the top non-ETN commodity deal with a $43.7 million issue of floaters linked to the Dow Jones - UBS ExEnergy 3 Month Forward Total Return Sub-Index.

Reflecting a trend seen with equity deals, the structure for this transaction was hybrid, incorporating rates and commodities elements.

The deal pays a coupon equal to one-month Libor minus 20 basis points, and the notes are callable if the index falls to or below 50% of its initial level.

Hedging today's rally

One factor behind the success of the volatility and energy ETNs, according to a market participant, could be that despite recent gains, investors remain skeptical about the longevity of the stock rally and are looking for hedges against a potential correction in the equity market.

"Macroeconomic forces are driving stocks, and investors, despite the rally, remained uncertain about the direction of stock prices, especially with the Fed saying that it will print more money," said Maarten Spek, financial research analyst at ECR Research.

Talking about the negative correlation between volatility and equity, which is the basis for investors' interest in the VIX ETN, he said that, "Falling stocks will immediately be followed by a spike in volatility. It creates more demand for put options on the exchange.

"Investors buy volatility for two reasons: to hedge equities and to be long volatility, as an asset class."

Untapped opportunity

Currencies-linked notes continued to be weak last week albeit slightly higher than the week before, up to $7 million from $2 million. As a percentage of total issuance, this asset class has dropped to about 2.5% this year from 6% in the first nine-and-a-half months of last year, according to data compiled by Prospect News.

"The focus is now on emerging markets as investors see the dollar falling further," said Spek, who added that the Fed's intent to continue to print money is putting the dollar under a greater pressure. Yet, the market did not price deals giving investors a bearish exposure to the dollar. "I'm not sure exactly why. Investors are playing this in the futures market, not with notes. It's more tradable and probably cheaper," said Spek.

There was only one rate-linked deal last week. It came from Bank of America Corp., which sold $24 million of callable capped notes based on the 10-year and two-year Constant Maturity Swap rates.

The league tables were a reflection of who issued the top ETNs. Barclays naturally topped the list with four deals totaling 76% of the week's issuance, followed by JPMorgan selling 10% of the total volume.

Merrill Lynch, Goldman Sachs and UBS were next with approximately 3% of the total each.

"Since there is a very high negative correlation between volatility and equity, the VIX ETN is a good hedging tool." - A sellsider

"Investors are playing [currencies] in the futures market, not with notes. It's more tradable and probably cheaper." - Maarten Spek, financial research analyst at ECR Research

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