Issuance drops 57% to $660 million; end of quarter, inflation fears seen as driving flow

By Emma Trincal

New York, Oct. 6 - Issuance fell by 57% to $660 million for the week ended Friday, an unusually low flow for the final week of a month.

The close of the third quarter and a pull-back from equity-linked issuance due to the prevalence of anti-inflation bets amid the Federal Reserve's preparations for more quantitative easing may help explain the tepid issuance, sources said.

Exchange-traded notes were not even a skewing factor: There were no ETNs priced during the week prior to last week while a $100 million ETN offering priced last week, according to data compiled by Prospect News.

If anything, the fact that issuance was so low despite the $100 million ETN issue strengthened the notion that last week was remarkably frail, sources said.

Quarter-end

"Everybody did poorly," said Charlie O'Flaherty, principal at Third Reef Holdings and former head of retail structured products at Bank of Ireland. "But it may have to do with the quarter ending," he added.

"Some people may have met their target on their quarterly benchmark. That can definitely have an impact," he said, noting that the trend is even more pronounced on the year-end.

"Over the quarter-end, a lot of bonds are expensive to borrow. People who have lent them on the repo market need to have them back on their books. It makes bonds harder to find."

The same trend was seen last year during the last week of September. Sales declined by 70% from $1.95 billion during the week of Sept. 20, 2009 to $387 million during the week of Sept. 27, 2009, according to data compiled by Prospect News.

Small is huge

While the overall volume shrank last week, the number of deals skyrocketed nearly three-fold to 219 from 84, reducing the average deal size to $3 million from $18.5 million.

The miniaturization of deals in general was a direct result of tiny reverse convertibles pouring into the market, which is not uncommon for the end of the month, sources said.

Reverse convertibles were the top structure, outpacing ETNs, with $136 million issued, which accounted for 20% of the volume. There were $312 million sold the week before in this category, amounting to the same 20% proportion of the total. The difference was that it took 132 deals last week, versus only 14 the prior week, to generate a volume almost 2.5 times smaller. As a result, reverse convertible offerings saw their average size drop to $1 million from $22 million, which is an even greater drop than the rest of the market.

There were only two reverse convertible deals exceeding $10 million last week, both of which came from UBS.

UBS AG, London Branch priced $15.13 million of 9% yield optimization notes due Sept. 30, 2011 linked to the common stock of Hartford Financial Services Group, Inc. and $13.23 million of 10.8% yield optimization notes with contingent protection due Sept. 30, 2011 linked to the common stock of Cummins Inc.

Equity retreat

Equity-linked issuance receded below the 50% mark last week, with $310 million sold, down to 47% of the total from 75% the week before. Most weeks this summer, equity issuance held higher at about 65% to 85% of the total.

While stock-linked issuance remained even at 25% of the total volume, equity index-linked products recorded a noticeable retreat. They fell to 21% of the volume from 52%.

"Volatility has come off on the indexes. If you need a reverse convertible or an autocallable, you need to go on a single stock," said Jakob Bronebakk, a structurer and associate partner at Jubilee Financial Products.

"Last week was a good week for equities, so it's a paradox. But people are not sure where the market's headed."

For some, the downturn of equity index-linked deals is not surprising.

"I'm fairly bearish on equity indexes, and I think retail investors are catching up with reality. We've had irrational exuberance, to paraphrase the Fed, but there's no reason to be exuberant. Growth is not there. Unemployment is not recovering. There's not much to feel good about," said O'Flaherty.

Commodities and inflation

Commodities continued their ascent as an asset class last week. Commodity-linked notes represented 27% of total issuance versus 13% the week before.

The two largest deals were linked to commodities, with the No. 1 deal coming from UBS AG, Jersey Branch with its $100 million of 0% 1x monthly short exchange-traded access securities due Oct. 1, 2040 linked to the Alerian MLP Infrastructure Total Return index.

This new product with a short exposure is a continuation of a series of ETNs linked to the same index comprised of 25 energy infrastructure master limited partnerships. Constituents of the index earn the their cash flow from the transportation and storage of energy commodities.

Interpretations on the success of the deal varied. For some, it was a hedge against a recession.

"Infrastructure is quite cyclical," said Bronebakk. "You can think of this as a general hedge, a macroeconomic hedge."

For others, the deal helped some investors protect existing long positions in this increasingly popular asset class.

"So many people hold those MLP ETNs on energy. Maybe it was time for some to get short," said a market participant.

The UBS ETN trade, which is a short exposure to an energy subset, is hardly a typical commodity bet, sources noted. Yet, several market participants saw in the flow of commodities deals last week, especially deals linked to gold, the sign that investors are now looking for a hedge against inflation.

Last week's second-largest offering was based on gold.

Goldman Sachs Group, Inc. priced $66.49 million of 0% commodity-linked trigger notes due Oct. 14, 2011 linked to the price of gold.

A market participant said that given the strong run of gold, a short-term correction is "conceivable."

Yet, he added, asset allocators who focus on the long term are likely to hold on to their long positions as there are still fundamental reasons to be bullish on gold.

"You can't say that gold is overbought. It's still a real store of value, which the dollar isn't," said O'Flaherty.

"The underlying factor [for] gold is inflation fear," said Bronebakk.

UBS also priced $13.77 million of 0% autocallable optimization securities with contingent protection due Oct. 3, 2011 linked to the Market Vectors Gold Miners exchange-traded fund. It was the sixth-largest transaction in size, and several agents, such as Barclays and Deutsche Bank, also priced deals tied to the price of gold.

"Inflation fears were dominant last week," said Bronebakk. "And the noise around the Fed doing more quantitative easing is driving some of the flow."

"Commodities are an inflation hedge. Nominal prices of commodities go up with inflation in order to keep the real value of prices constant."

UBS leads

UBS topped the week due to its ETNs, its larger-sized reverse convertible deal and its autocallable product linked to the Market Vectors Gold Miners ETF.

Morgan Stanley was No. 2. It was also the champion of big deals, selling eight offerings averaging $43.5 million.

A surprise was the rise of Wells Fargo to the fifth slot through a couple of larger deals. This agent sold $15.19 million of 0% autocallable access securities due Oct. 10, 2012 linked to the S&P 500 index on the behalf of Eksportfinans ASA. Wells Fargo & Co. also priced $13.17 million of 0% enhanced growth securities due Oct. 5, 2012 linked to the Russell 2000 index.

Year-to-date, Morgan Stanley, UBS and Wells Fargo are respectively No. 4, No. 5 and No. 11.

The top agent so far is Barclays, followed by Merrill Lynch.

"Everybody did poorly. But it may have to do with the quarter ending." - Charlie O'Flaherty, principal at Third Reef Holdings and former head of retail structured products at Bank of Ireland

"Inflation fears were dominant last week." - Jakob Bronebakk, a structurer and associate partner at Jubilee Financial Products

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