Merrill Lynch prices half of volume in solid week, but October's monthly sales finish down 5%

By Emma Trincal

New York, Nov. 2 - Bank of America Merrill Lynch priced nearly half of last week's issuance in a solid week.

But October as a whole disappointed. Volume for the month was down 5% compared to September, according to data compiled by Prospect News.

Merrill Lynch, as is almost always the case, was the top agent for the last week of the month.

In the week ended Friday, it priced $495 million, or 46% of the total.

The top five offerings were all sold by Merrill Lynch, as well as seven out of the top 10 deals, the data shows.

"The thundering herd is still alive and well," a market participant said.

Merrill Lynch was able to sell deals of a much larger size than the average. It sold 18 out of the week's 188 offerings.

Agents last week sold $1.07 billion, up 78.5% from $600 million sold in 106 offerings during the prior week.

Figures do not include exchange-traded notes.

October

"It's a calendar cycle. The surge at the end of the month doesn't mean much," the market participant said.

During the last week of September, agents sold $1.88 billion, indicating a 43% decline from the last week of September to the last week of October.

On a month-to-month basis, sales in October weakened as well.

From Oct. 1 to Oct. 29, agents sold $2.97 billion, nearly 5% less than during the same period in September, which saw the pricing of $3.12 billion.

"Based on empirical and anecdotal evidence, October was the softest month of the year for us," the market participant said.

"The flow was definitely slower in October than September."

Equity

Equity-linked products surged for the week amid a remarkable one-day rally on Thursday, but the asset class was still down 17% for the month.

Equity-linked notes saw their volume soar last week to $800 million, up 204% from the previous week. Their market share also jumped week to week from 44% the week before to 75%.

But on a monthly basis, equities fell both in volume - down 17% to $1.82 billion - and in market share, falling to 61% from 70% of the total.

"October was weaker than September, and equity is the largest underlying, so it's not a surprise that it would collapse from one month to the next," the market participant said.

Sources said that both market sentiment and the calendar explained the strong equity bid seen last week.

The S&P 500 rose 3.7%, fueled by a one-day rally in Thursday that followed a last-minute agreement between euro zone leaders in Brussels to tackle the Greek debt crisis.

The benchmark jumped up 11% for the month, with the bulk of the rise taking place last week. Simultaneously, volatility declined by 23%, and the CBOE Volatility index, or VIX, fell below 25, a sign that fear was easing.

"The mood was very bullish. And unfortunately, people, especially retail, high-net-worth investors, tend to buy at the top and sell at the bottom," the market participant said.

Within equities, indexes did better than stocks, both on a week to week basis but also month to month.

Equity indexes rose by nearly 245% last week, while stocks grew by 115%.

For the month, both declined, but stocks (down 37%) fell more than indexes (down only 9%).

Risk off, risk on

"With volatility coming down, I would expect index products to do well, because the indexes are less volatile and you can afford to get more leverage," said a former structurer at JPMorgan.

Indeed, leverage remained the favorite structure, but a shift toward riskier trades occurred.

As the market rallied last week, investors bid heavily on leveraged notes without any downside protection. Those rose by 200% from the week before to $124 million.

At the same time, notes structured around a buffer or a barrier (partial downside protection), while remaining the prevalent category (20% of the total), decreased by nearly 9% to $207 million from $227 million the week before.

"The cost of buffering tends to be cheap when volatility is high," the former structurer at JPMorgan said, which is why those structures must have been more popular earlier in the month. "People's main motivation is to get a buffer when there is fear in the market."

He said that buffers are built by selling out-of-the-money puts in order to buy at-the-money puts.

"When volatility rises, when there is fear in the market, buffers are cheaper because you get paid well for selling the puts," he said.

"When there is a rally, volatility comes down. People can buy options cheaper and get leverage at a better price. At that point, people are more confident, they tend to buy more leverage, and they don't want the buffer."

But for the market participant, sudden volatility moves as seen last week are unlikely to modify investors' behavior.

"This is a retail market. For us, off-the-shelf products are our bread and butter. It's more the sophisticated investor, the institutional money that's going to take a view on volatility changes from week to week," he said.

"Retail investors are going to follow the calendar selling cycle."

Commodities showed a more consistent development, up both for the week (up 414%) and for the month (up 44%).

This asset class represented about 15.5% of the total both last week and last month.

"This is one of the asset classes that is the least manipulated by policy actions," the former structurer at JPMorgan said.

Reverse convertibles

The monthly figures suggest a continued decline in reverse convertible sales, even though last week's picture was rosier, with this type of structure up 32% at $51 million.

"Reverse convertibles are a calendar offering type of product. The week to week is not a particularly good analysis unless you're pricing a big one-off," the market participant said.

But last week revealed a volume decline of two-thirds from the $140 million of reverse convertibles brought to market in the last week of September.

The market participant explained that "most of the deals sold last week were put out at the beginning of the month when volatility was higher."

The VIX was at 45 at the beginning of October and finished at 30 at the end of the month.

In other words, the deals were being marketed at a time when volatility was still very high.

"People are scared," he said.

"Unfortunately, they tend to buy at the top and sell at the bottom. If you have a fundamental view around equity, the right time to buy reverse convertibles is when the volatility is high and the coupon is high. But that's not happening that way."

Top offerings

The top two deals of the week were two equity-linked step-up notes.

Bank of America Corp. priced $93.35 million of 0% market-linked step-up notes due Nov. 26, 2012 linked to the S&P 500 index.

If the index finishes above the step-up value - 108% of the initial level - the payout at maturity will be par of $10 plus the index return.

If the index finishes at or above the initial level but is less than or equal to the step-up value, the payout at maturity will be par of $10 plus the step-up payment of 8%.

Investors will receive par if the index declines by up to 5% and will be exposed to losses beyond 5%.

The second Bank of America step-up deal, an $84.19 million offering, had similar terms except for its two-year tenor, its 122.5% step-up value and 10% buffer.

The third largest deal was the top stock-linked note offering of the week.

Bank of America priced $55.79 million of coupon-bearing notes due Nov. 9, 2012 linked to the common stock of JPMorgan Chase & Co.

Interest is 13% a year.

If the stock finishes at or above 90% of the initial value, the payout at maturity will be par. Otherwise, investors will be exposed to losses beyond that threshold.

Merrill Lynch also sold the next two biggest deals, one issued by Bank of America and linked to the gold spot price for $45.63 million, the other for $39.18 million issued by AB Svensk Exportkredit and linked to the Rogers International Commodity Index - Excess Return index.

After Merrill Lynch, the second top agent last week was HSBC with $119 million in 29 deals for 11% of the total. It was followed by Goldman Sachs, which priced 15 deals totaling $92 million.

"Based on empirical and anecdotal evidence, October was the softest month of the year for us." - A market participant

"The cost of buffering tends to be cheap when volatility is high." - A former structurer at JPMorgan

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