Volume is up 11% for year so far; month ends with burst of BofA short-term, bullish notes

By Emma Trincal

New York, March 5 - February ended on a strong note with agents selling $1.60 billion in 269 deals, according to data compiled by Prospect News. The last week of January finished slightly higher with $2 billion in sales, but given that February saw several larger offerings, volume ended up higher than last month, growing 45% to $3.47 billion from $2.39 billion in January, the data showed.

The healthy pace of issuance has led to volume totaling $7.57 billion so far this year, an 11.16% increase from the $6.81 billion priced during the same period of last year. The number of offerings also rose to 1,517 from 1,345 last year, a 12.75% increase.

As always in the final week of the month, Bank of America deals prevailed in numbers and volume. BofA Merrill Lynch sold 16 of the top 20 deals including the top seven offerings.

Many of the largest structures were bullish in nature with no downside protection and had return enhancement features such as high leverage or a step-up payout, similar to a digital that would not cap the upside.

Volume up for year

"Getting more than 10% pickup in volume for the first two months of the year is very encouraging. It's a good sign. It bodes well for the market outlook for 2014," a sellsider said.

A market participant was more cautious.

"Flows are up. It's good, but it's still a little bit early to draw any definite conclusion," he said.

"Yes, we're getting more flows, and we're optimistic. But we're cautiously optimistic. We're not patting ourselves on the back yet."

He attributed the robust pace of issuance to the market itself.

"We had a bit of a correction early on in the year. It helped a little bit. We have a more constructive market, and people continue to allocate to equities," he said.

Equities as an underlying asset class are up 20% this year, according to the data. The bulk of the surge came from single stocks, which rose by 55%, while equity indexes are up by less than 6%.

Equity index notes are still the main asset class, making for 53.35% of the total versus 56% last year. But the market share of single-stock-linked notes issuance has increased to 28% from 20% last year.

Equities still in demand

"We have more volume, and that's driven by a bullish sentiment in the equity space that still prevails," the sellsider said.

"Equities have performed so well last year, people see value in being in the market and more investors are increasing their allocation to the asset class.

"People are catching up. Even if the S&P has been flattish so far this year, a lot of investors who were reluctant to invest in equities last year now want to make up for the missed opportunities. People are looking at what's available now and how to take advantage of the market now. There is more interest in structured products as they offer ways to invest in the market that would not be available elsewhere."

The S&P 500 index gained 32% in 2013.

It is up about 1.5% year to date after a sharp selloff at the end of January. Last month, the benchmark recouped some of its losses with a positive performance of 5%.

The appeal of alpha

A second factor explaining the strong demand for structured notes, this sellsider said, is the greater interest in research-based products such as notes linked to baskets of stocks selected by equity analysts at top research firms.

"Those structures are getting the attention of new-comers. We've seen a couple of larger deals this year, in particular the Bank of Montreal annual offering linked to Raymond James stock picks," he said.

"We'll see more of this in 2014 because the research will attract new types of investors, those who are not necessarily traditional buyers of structured products. The bid on those research-based strategies has an impact on volume because it is enlarging the group of market participants."

Retail investors are always looking for new forms of alternative investments, he noted. Unlike hedge-fund-like strategies, structured products linked to research-based stock picks by some of the best analysts on the Street are "very simple" to understand, he said.

"They offer clear strategies and could have a wider appeal as the structured products market expands."

Short-term return enhancers

The top products last week focused on giving investors more upside potential in a moderately bullish market with no downside protection, using for the most part higher levels of leverage or digital-like types of payouts in the form of step-ups. Those deals, all distributed by BofA Merrill Lynch, had in common a relatively short duration, according to the data.

"If you're going to have a short-term-dated product, something shorter than two years, then usually the perception is that risk is not that significant. People are fairly comfortable with the underlying; they're comfortable with the outlook. Therefore, the main goal is to obtain some form of return enhancement, either through a step feature or by leveraging the upside," the sellsider said.

300% leverage

The top two deals are capped and feature high leverage on the upside and no protection on the downside. They both exceed the $100 million mark.

The top sale was Credit Suisse AG, London Branch's $102.3 million of 0% Accelerated Return Notes due April 24, 2015 linked to the S&P 500 index. The upside is leveraged at a rate of three times up to a 10.26% cap. Investors have one-to-one exposure to any decline.

Similar in structure, the second largest offering was AB Svensk Exportkredit's $101.3 million of 0% Accelerated Return Notes due April 24, 2015 linked to the Euro Stoxx 50 index. The upside participate rate is 300% subject to a maximum return of 14.7%. Investors also have one-to-one exposure to any index decline.

Step-ups

Following the same structure - short duration, three-times leverage, a 16.11% cap and exposure to any losses - was Barclays Bank plc's $48.35 million of 0% Accelerated Return Notes due April 24, 2015 linked to a basket of three equally weighted financial sector stocks, which were Citigroup Inc., JPMorgan Chase & Co. and Wells Fargo & Co. The offering, also distributed by BofA Merrill Lynch, was the No. 6 in size.

Step-up structures were the other type of short-term, Bank of America big deals with structures designed to enhance returns rather than protect the downside. The third, fourth and fifth largest deals of the week employed this structure.

Deutsche Bank AG, London Branch priced $77.62 million of 9% STEP Income Securities due March 13, 2015 linked to the common stock of General Motors Co. Interest is payable quarterly.

If the final price of GM stock is greater than or equal to the step level, the payout at maturity will be par of $10 plus 1.76%. The step level is 109% of the initial share price.

If the final share price is greater than or equal to the initial share price but less than the step level, investors will receive par. Investors are fully exposed to any losses.

Credit Suisse priced the fourth largest deal, another step-up, which unlike Deutsche Bank's product offers no fixed interest rate. It was a three-year $68.79 million autocallable step-up linked to the Euro Stoxx 50.

The notes are automatically called on two annual observation dates if the index is greater than its initial level with an 11% call premium on the first call date and 22% on the second call date. The step-up value is 139.5% of the initial level, with investors receiving a 39.5% return for any final index growth comprised between the initial level and the step-up value. Above the step-up, investors receive par plus the index return. Investors have no protection on the downside.

Buffered note

Bank of America Corp. issued the fifth largest deal, also a step-up with a tiny 5% buffer, in its $62.7 million of 0% autocallable market-linked step up notes due Feb. 26, 2016 tied to the PHLX Housing Sector index.

The largest product among the top deals to offer a significant buffer was Credit Suisse's $44.11 million of 0% Leveraged Index Return Notes due Feb. 22, 2019 linked to the Dow Jones industrial average. It was the No. 7 deal of the week. The structure is uncapped but longer in duration with a small leverage factor of 1.08. However, investors benefit from a 20% buffer.

"Once you go to longer maturities, the outlook becomes a little bit more uncertain. That's when you start focusing more on incorporating downside protection," the sellsider said.

Credit Suisse, a popular issuer

As an issuer, Credit Suisse was the most widely used name last week, accounting for $502 million of the volume in 33 deals, which is 28% of the total, according to the data.

Bank of America seemed to have been using Credit Suisse more this year than last year, according to the data. During January and February, the use of Credit Suisse credit made for 30% of Bank of America's sales volume versus 9.5% last year, according to the data. Credit Suisse as an issuer accounted for 21% of the number of offerings priced by Bank of America this year versus 5.5% last year.

"If Bank of America is beginning to use Credit Suisse more, then my guess is that Credit Suisse has more attractive funding levels and they're trying to take advantage of it. It also means better economic terms for the client, which is also an incentive," the sellsider said.

"It's more dependent on Bank of America's appetite for Credit Suisse than anything else," the market participant said.

Commodities

Sources noted that commodities issuance is still lagging this year despite a rally in this asset class.

Commodities-based volume dropped by 41% to $227 million from $384 million last year, according to the data.

The number of offerings shrank nearly by half to 17 from 30.

Meanwhile, the Dow Jones-UBS Commodity Index Total Return is up 8.45% this year, outperforming the Dow Jones industrial average by nearly 10%. The equity benchmark is down 1.35% for the year.

"I think if commodities continue to rally, it's only going to be a matter of time before we see more sizable offerings in this asset class," the sellsider said.

"Investors are probably looking for a more sustained rebound or for a more definite outlook from the main wirehouses.

"Whenever there is an opportunity such as commodities now, when all attention has turned elsewhere, it's a perfect time to jump in.

"Perhaps when some of the strategists at Goldman Sachs, Merrill or JPMorgan begin to make some bullish calls, you will see bigger deals in greater numbers in the commodities space. It's something to keep an eye on."

BofA Merrill Lynch was the top agent with 24 deals totaling $833 million, or 52% of the total.

UBS was next followed by Barclays.

"It's still a little bit early to draw any definite conclusion." - A market participant

"Investors are probably looking for a more sustained rebound or for a more definite outlook from the main wirehouses." - A sellsider on the lagging volume of commodity-linked deals

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