Slower, holiday-shortened week records $381 million of volume; fixed-coupon deals dominate

By Emma Trincal

New York, Sept. 10 – The first week of September was a short one after the Labor Day weekend and a slow one, leading to a volume size of $381 million in 117 deals as of Friday, according to data compiled by Prospect News.

The week featured one large offering linked to a stock and brought to market by Wells Fargo & Co. followed by four deals that appeared to have been pieces of the same order for one client, sources guessed.

As a main trend, fixed coupons topped the deal list, with strong demand for autocallable reverse convertibles, according to the data.

Wells Fargo priced the best-selling product, $75 million of 8% equity-linked securities due Aug. 28, 2015 linked to the common stock of Archer-Daniels-Midland Co.

The last time Archer-Daniels-Midland was employed as an underlier was in 2009 when Barclays Bank plc used it to structure six reverse convertibles totaling $9 million, the data showed.

Big and complex

The structure is relatively “complex,” according to a source.

It features two strikes on the upside, one at 108.5% of the initial share price and the other at 110.5%. If the stock finishes above the higher strike, investors get a 65% participation in the upside. Between the two strikes, they get par. Below the lower strike, they get 0.9216 multiplied by the final share price, provided that the payout will not be less than $39.3231 per note. The face amount of the notes is $50.1954, which is equal to the initial share price.

“My guess is it’s for an institutional investor,” a sellsider said.

“It’s pretty unusual. All the options are simple options, but the combination is pretty strange. It must be for the particular view or need of the investor.”

Four on one

Another “strange” aspect of last week’s top offerings was the presence of several fixed-interest deals issued by different issuers acting as their own agents in a mode of distribution that contrasted with the more traditional open architecture model.

This group of deals used worst-of payouts. The same pair of underliers was used in each, the Russell 2000 index and the iShares MSCI EAFE exchange-traded fund.

HSBC USA Inc. priced $19.24 million of 5% buffered fixed-rate notes due Dec. 9, 2015 linked to the Russell 2000 and the iShares MSCI EAFE ETF.

If the least-performing asset finishes at or above 85% of its initial level, the payout at maturity will be par. Otherwise, investors will share in the losses of the least-performing asset at a rate of 1.17647% per 1% drop beyond the 15% buffer.

HSBC Securities (USA) Inc. was the agent.

Barclays priced $15.95 million of 5.55% autocallable notes due Dec. 8, 2015 linked to the lesser performing of the iShares MSCI EAFE ETF and the Russell 2000.

The notes will be automatically called at par plus accrued interest if each underlying component closes at or above its initial level on any quarterly call valuation date.

If the notes are not called and the return of the lesser-performing underlying component is greater than or equal to negative 20%, the payout at maturity will be par. Otherwise, investors will lose 1.25% for every 1% that the lesser-performing underlying component declines beyond 20%.

Barclays was the agent.

Deutsche Bank AG, London Branch used the Barclays deal to price $15.2 million of 5.15% autocallable securities due Dec. 10, 2015 linked to the lesser performing of the same two reference assets, with Deutsche Bank Securities Inc. acting as the agent.

Finally JPMorgan Chase & Co. did the same with a longer maturity, pricing $15.19 million of 5.25% single observation autocallable yield notes due March 10, 2016. J.P. Morgan Securities LLC was the agent.

Fee-only scenario

“Looks interesting,” a source said.

“Perhaps it is for a large RIA or private bank or institutional account who wants credit diversification.”

The sellsider noted that none of the four issuers were among the “wirehouses.” Although JPMorgan was among those four, “[it] is not technically considered a wirehouse even though they have a distribution capacity comparable to a wire's.”

The distribution of those four offerings showed a slightly different pattern than usual, he said.

“Most everything comes from Merrill Lynch, Morgan Stanley, UBS, JPMorgan, Wells Fargo. They are big distributors and act as their own agents. It’s different here. We’re not in a scenario dominated by the wirehouses. But obviously we’re dealing with the same client. It’s the same underlier. They all use a worst-of. It makes sense to imagine that it was sold to the same party,” he said.

“My guess is that it’s for a fee-only [registered investment adviser], just by looking at the fees.”

The fees were 5 basis points on three deals except for the JPMorgan issue at 15 bps.

“It’s very likely that the investor is an RIA. Now whether a broker-dealer is involved or not, we don’t know. So many people call themselves RIAs, but many are affiliated with brokers. What’s for sure is that this is not a cash commission-based deal,” he said.

This sellsider said that it would be “interesting” if a small, independent broker-dealer had been involved in the deal although impossible to tell.

“Small brokers have their hands tied by compliance, and they have a tough time getting their compliance people to approve new or complex products. A worst-of is not a simple structure, so either there is no broker-dealer involved or the compliance people are becoming more open,” he said.

Real estate plays

Two other deals using the same underlier followed. This time though the structural differences and the fee amounts led sources to rule out the idea that the same client was behind the offerings.

Goldman Sachs Group, Inc. priced $11.21 million of leveraged buffered notes due Oct. 10, 2017 linked to the iShares U.S. Real Estate exchange-traded fund. The leverage factor was two. The cap was 40.6%. The buffer was 15% with a 1.1765 leverage factor beyond the buffer threshold.

Goldman Sachs & Co. was the underwriter. The deal carried a 2.2% fee.

Separately, Deutsche Bank AG, London Branch priced $10.53 million of 0% contingent minimum notes due Sept. 7, 2018 linked to the iShares U.S. Real Estate ETF.

If the fund finished at or above its initial level, the payout at maturity would be par plus the greater of the gain and the contingent minimum return of 44.5%.

Investors would be exposed to any losses.

Deutsche Bank Securities Inc. was the agent and the fee was 3.47%

Notes with fixed coupons prevailed last week, including the top five deals.

Traditional reverse convertibles accounted for 8% of the total and this structure type with an autocallable feature made for 36% of the volume versus 20% for the year to date average, the data showed.

Coupons wanted

“Everybody is looking for yield. Everybody wants coupons,” the sellsider said.

“The market is pulling back a little. People want something tangible. Even if you’re bullish on the underlying stock, you may still need the income, and that’s why those reverse convertibles are popular.”

Another reason may be that buffers are hard to price.

“Having a coupon and having a buffer in some ways is very similar. You get a real cushion, some unconditional protection,” he said.

The tendency to add more features to the typical reverse convertible such as a call and a worst-of payout is another sign that investors are hungry for yield, sources said.

“The autocall is going to give you a better headline yield. If you add the worst-of to that, you can enhance the yield even more,” said Joe Halpern, chief executive of Exceed Investments.

Getting a fixed return when the anticipation is that the market will trade sideways could also be a driver behind the income product trend seen last week.

“The market is a bit toppy. People may be looking at that. They may think we’re stuck here for a little bit. The S&P reached the 2,000 level. It’s only a number, but psychologically it’s important,” Halpern said.

Buyer beware

A distributor said investors should remain cautious, however.

“You have two distinct parts of the market: the fixed-income side and the equity side,” he said.

“Everyone who invests should have some sort of balance, not necessarily 50-50 but some balance. Don’t substitute fixed income with an equity product just because it looks like fixed income. It’s not.

“I fear – or I should say, I hope – that people don’t use those barrier notes, those reverse convertibles as an alternative to fixed income just because yields are so low. If they do, it gets a little dicey. The idea of buying an 8% reverse convertible and to say, ‘I’m beating the five-year or 10-year Treasury’ is very dangerous. It’s not the same. The fixed-income market and the equity market work independently.

“With a reverse convertible, your underlying is a stock. If you use it for an equity replacement, that’s fine because you know what you’re getting into. But if it’s to replace a fixed-income portion of your portfolio, that’s a mistake. If the market goes through a major correction, which is likely, you’ll wind up losing your coupon plus some of your principal and you’re not going to be happy.”

Wells Fargo was the top agent last week with its unique $75 million deal accounting for nearly 20% of the total volume. It was followed by UBS and JPMorgan.

“All the options are simple options, but the combination is pretty strange.” – A sellsider on Wells Fargo’s securities linked to Archer-Daniels-Midland Co. stock

“The market is a bit toppy. People may be looking at that.” – Joe Halpern, chief executive of Exceed Investments

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