Issuers price $405 million in quiet, pre-earnings week marked by strong bid on single names

By Emma Trincal

New York, Jan. 15 - In what some may consider the first week of the year, issuers sold $405 million in 106 deals last week and showed a strong preference for equity-linked products, in particular single stocks, according to data compiled by Prospect News.

The overall equity market was quiet with the S&P 500 index finishing flat despite a disappointing job report on Friday, which against most expectations lifted stock prices as it eased investors' fear of further tapering, sources said.

But in the back of their minds, investors were already focusing on the upcoming earnings season, said Paul Weisbruch, vice president of options sales and trading at Street One Financial.

"I think the market this year will be more earnings-related, not as much Fed-related as it was last year," Weisbruch said.

For the year as of Saturday, sales were $578 million, down by a third compared to $864 million priced during the same period last year, the data showed.

The most popular structure seen last week was the autocallable reverse convertible, with 42.5% of the total volume in 70 deals. Those issues were linked to single stocks. Most of those products were small in size. There were only six larger deals in excess of $10 million, but those accounted for 60% of the $172 million issued in this structure type, according to the data.

Volatility to pick up

Autocallable reverse convertibles were one of the most popular structures last year. Sources, however, were questioning the strong bid in a week characterized by little volatility or action.

"Last week was flat with not much going on. It was very tight-range with not much news, not much activity. But the upcoming earnings season is just at the corner, and it was already on the radar last week even though volatility stayed flat," Weisbruch said.

"The market continues to challenge new highs, especially in the small-cap space. Just [Wednesday], the small-cap benchmark hit an all-time high.

"As the earnings are just creeping up on us, volatility is going to pick up. We've already seen that this week with the steep sell-off on Monday.

"From the end of January through February, we have a number of pivotal earnings coming up. This is going to be the key for the direction of the market this year.

"What's been happening in 2013 was unquestionably very bullish. But from now on, volatility is going to increase. We've seen some evidence of that already."

Earnings coming

Equity-linked notes made for 80% of last week's total volume, which is above average, according to data compiled by Prospect News. Single stocks made for 43.5% of the total volume, which is above the 23% market share they represented last year.

"This is also related to earnings, I guess," Weisbruch said.

"Stock pickers are attracted to catalyst-driven events. The earnings season is going to bring plenty of that. At the same time, some investors are taking chips off the table and re-evaluating some sectors."

The top autocallable reverse convertible deal and the week's third largest issue was Morgan Stanley's $32.07 million of contingent income autocallable securities due Jan. 17, 2017 linked to the common stock of Apple Inc. The notes pay a contingent quarterly coupon at an annual rate of 12% if the stock closes at or above its 80% barrier level on the determination date for that quarter.

The notes will be called at par plus the contingent coupon if the stock closes at or above the initial price on any of the first 11 determination dates.

The payout at maturity will be par plus the final contingent coupon unless the stock finishes below the 80% barrier level, in which case investors will receive a number of Apple shares equal to par of $10 divided by the initial share price.

The lull before the storm

Michael Iver, chief executive of iVerit Consultancy and a former structurer, said upcoming earnings may be one of the many "hypothetical" explanations behind the strong bid on autocallable reverse convertibles last week despite flat volatility levels.

"We are just before earnings season. It's the beginning of the year. Maybe this is the lull before the storm. Investors are confident about putting single-names trades. It's easier to have conviction before you get increased volatility on single names," he said.

"Issuers are now focusing on single-name selection and stock-picking in the face of a very buoyant equity market.

"The strong concentration of deals in single stocks reflects what Wall Street has been pushing for, which is to look at single stocks in order to give investors outperformance since the overall market has done so well over the past year."

Fearful bulls

Autocallable reverse convertibles are not the instrument of choice for the very bullish investor, he noted.

"These deals are a chicken way of getting exposure to the bull market. You are selling put volatility. You're not really so bullish on the markets, but if it traded off, you would be willing to buy the underlying at those levels.

"These are not aggressively bullish deals, but they reflect a desire on the part of investors to still participate in the rally," he said.

The autocallable feature is one that enables issuers to boost the return compared to a traditional reverse convertible, he explained.

"In the face of lower volatility, the only way you can get a decent coupon, one that resembles what people are accustomed to, is by doing the autocallables," he added.

Finally as investors are jittery about a potential correction in 2014, autocallable reverse convertibles may well be suited for the mildly bearish view, he said.

"Investors in the structured notes market don't naturally gravitate towards bearish instruments," he said.

"I have rarely seen bearish structured products. But given how high the market has been trading so far, perhaps the bid on those single-stock autocalls reflects the ambivalent market view of people who are no longer aggressively bullish but still want to fearfully take advantage of the rally."

Fear in the market

Leveraged notes with or without buffers or barriers made for 24% of the total last week in 14 deals, a smaller proportion than usual, according to data compiled by Prospect News. Equity index underliers often used in those products accounted for only a third of the week's issuance versus 37% for last year.

"I would've expected to see more levered deals against indices," Iver said.

"When the market is trading up and volatility is trading down, buying options to provide leverage to indices is very inexpensive. I would've thought you would see more of it.

"Perhaps it reflects the fact that people are not as confident about the market's continued direction. If they were still bullish, demand for leverage, even capped leverage, would have been stronger.

"Last week's issuance shows there is fear in the market."

Top deals

Credit Suisse AG, London Branch's $32.53 million of 0% Accelerated Return Notes due March 27, 2015 linked to the Euro Stoxx 50 index was the top leveraged deal last week and the second in size. It offered three-times leverage on the upside up to a 16.41% cap with no downside protection. BofA Merrill Lynch was the agent.

The top offering was a short-term tracker note with a one-to-one exposure to a global equity index on both the downside and the upside.

Goldman Sachs Group, Inc. priced $50 million of 0% notes due April 10, 2014 linked to the Topix index at 100.08.The payout at maturity will be par plus the index return. If that return is negative, investors will receive less than par.

The initial index level set for the notes, 1,295.70, is higher than the actual closing level of the index on the pricing date, which was 1,292.15.

Goldman Sachs & Co. was the underwriter.

"Maybe it was one investor, and possibly an institutional investor, who wanted guaranteed liquidity at the end of the deal, when they would have had to sell the Topix ETF," Iver said.

The top agent last week was UBS, which priced 67 deals totaling $96 million, or 23.64% of the total. It was followed by Morgan Stanley and Goldman Sachs.

"I think the market this year will be more earnings-related, not as much Fed-related as it was last year." - Paul Weisbruch, vice president of options sales and trading at Street One Financial

"Last week's issuance shows there is fear in the market." - Michael Iver, chief executive of iVerit Consultancy

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