In a busy week, Barclays, RBC, Eksportfinans lend their balance sheets to agent Merrill Lynch

By Emma Trincal

New York, March 30 - Issuance grew in volume by 93% to reach $1.56 billion in a week marked by Merrill Lynch's dominance, notably its use of several other issuers' names to sell deals on its platform, according to preliminary data compiled by Prospect News. The data excludes exchange-traded notes.

Merrill Lynch sold five deals issued by Barclays Bank plc, including the top deal of the week ended Friday: Barclays' $136.73 million of 0% Accelerated Return Notes due May 25, 2012 linked to the S&P 500 index.

Among the top 11 deals of the week, Merrill Lynch was the agent for three deals issued by Royal Bank of Canada as well as three others issued by Eksportfinans ASA.

"Merrill has been doing it for a while. The news is that they're doing it more," a New York-based market participant said.

"I've seen Merrill using Eksportfinans many times before. But I haven't seen many with Barclays," a distributor said.

Credit diversification

Two sources explained that Merrill Lynch's relationship with other issuers last week was different from a mere open-architecture process. It involved diversification of credit with Merrill Lynch remaining the manufacturer of the deals.

"It's not open architecture, like what UBS and JPMorgan do. It comes from the manufacturing side, not the distribution side. If it was open architecture, Merrill would not be included at all and would just be bidding out a deal," the market participant said.

A sellsider explained the difference in those terms: "Open architecture and credit diversification are two different things.

"With open architecture, the agent tells different firms: show me your best idea, at the best price. We'll buy these notes. And the agent simply buys the notes from the issuer.

"But from what I know about Merrill, Merrill arranges the notes. They have an idea of what they want. They structure the product. They go to an issuer. They only use the credit of the issuer. And they will hedge the product themselves.

"That's what they've been doing for a few months now. It's possible that they may be doing this more and more. It makes sense.

"I think it's a good thing for the client. It's good for the client, and it's good for the industry."

A structurer noticed the trend as well.

"Merrill works with different issuers from time to time for credit-diversification purposes. That could be what they're doing here," he said.

Ultimately, clients and financial advisers benefit from the use of multiple issuers, the market participant said.

"Whenever you see different issuers going through Merrill Lynch's platform, it means an increase of the use of balance sheets of other firms. The credit risk is now borne by the other issuer, and it's helpful for clients," he said.

The market participant also distinguished between the concepts of open architecture and credit diversification. He said that Merrill Lynch was not involved in open architecture but instead remained the structurer in those deals.

"If it's the issuer that's on the back end of it and structures the deal, it's called open architecture. But if it's Merrill Lynch's equity derivatives desk that's the arranger, it's different. In this case, Merrill comes up with a strategy, hedges the structure and has someone else issue it so that they can diversify the credit.

"It's my understanding from what I know about Merrill that it's Merrill's derivatives desk that's diversifying the credit risk for the investors. It's not coming from the firm's proprietary distribution channel. Having other issuers with strong credit risk stepping in and issue the notes is always a plus for investors."

However, the market participant said that using other firms' balance sheets can be complicated.

"Merrill is not taking 100% of the proceeds because of the cost of borrowing a balance sheet. It's not simple to structure deals with another name. Issuers have funding targets, and some may be out of reach for Merrill.

"Also there are not a lot of firms that lend their balance sheet as they want to maintain control of their deals."

The structurer said that using other banks' balance sheets may be necessary in order to maintain good relationships with counterparties.

"A structured note has a derivative portion to it. Nobody is an island really. If they have to get prices from the street and talk to 10 or 15 dealers and investment banks, they may also have to work with those firms," he said.

But the sellsider disagreed. "There is no relation between who the issuer is and who the counterparty is."

Bullish sentiment

Investors' exposure to equity continued to grow. It increased to $1.099 billion last week from $724 million during the preceding week.

A renewed interest in commodities was also visible with $252 million sold versus $50 million the week before.

The market's "fear gauge" as measured by the Chicago Board Options Exchange Volatility index, or VIX, continued to decline, which puzzled market participants given the Japanese crisis and the war in Libya, sources said.

This market trend implied the continued prevalence of leveraged deals, as the cost of leverage is cheaper when volatility is down. Leverage amounted to 42% of the volume.

Meanwhile, investors expressed their bullishness by biding on leveraged notes without protection or buffers. Leveraged notes without downside protection represented more than a third of the week's volume, according to data compiled by Prospect News.

Top offerings

After Barclays' $136.73 million deal linked to the S&P 500, the second-largest offering was a stock deal: Citigroup Funding Inc.'s $111.37 million of 12% Equity LinKed Securities due Sept. 21, 2011 linked to the common stock of United States Steel Corp.

Merrill Lynch sold the third-largest deal using Eksportfinans as the issuer with a $94.14 million of 0% Accelerated Return Notes due May 31, 2012 linked to the Rogers International Commodity Index - Agriculture Excess Return.

After Merrill Lynch, Barclays was the second top agent with 16 deals totaling $310 million. It was followed by Citigroup with $229 million sold in five deals.

The week before, Goldman Sachs was No. 1, followed by UBS second and JPMorgan third.

"It's not open architecture, like what UBS and JPMorgan do." - A market participant

"Nobody is an island really." - A structurer

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