BofA tops in early push; week sees record levels of equity volume, leverage with no protection

By Emma Trincal

New York, July 16 – In the week ended Friday, the second of the month, Bank of America’s presence was unusually strong for an agent that typically prices its deals in the last week of the month.

Additionally, the volume of deals linked to any equity asset – indexes, stocks, exchange-traded funds or baskets – was disproportionally higher than average, indicating that bullishness continues to dominate the retail market.

Finally, the proportion of unprotected leveraged notes was also unusually high, according to data compiled by Prospect News.

Agents sold $500 million last week in 90 deals versus 114 offerings totaling $591 million in the prior week, according to the data. At $806 million, the month-to-date volume was up 60% compared to the same period in June.

For the year to date, sales have grown slightly more than 13% to $22.17 billion from $19.57 billion, according to the data.

BofA tops early

Bank of America alone priced $253 million last week in only seven deals, a nearly 55% share of the total volume issued. These levels are not uncommon for end-of-the month issuance, but the timing of those sales occurring in the first half of the month surprised sources.

JPMorgan was the No. 2 agent with 14 deals totaling $108.25 million, or 21.65% of the total. Barclays was next with $40 million in four deals, or 8% of the total, according to the data.

“This is interesting. I don’t know why they would have such a big week. That’s a surprise to me,” a distributor said. “I know that they’re in the process of freeing up some of their restrictions to increase the minimum size of their private deals. But first, it hasn’t happened yet. And second, that wouldn’t be it since we’re talking about a handful of big deals.”

“They are becoming the top shop in equity derivatives,” a sellsider said.

“They’re well ahead in the distribution game. But they’re beating houses like Goldman or JPMorgan, who used to compete with them more and put together some of the best products.

“The powerful salesforce they have at their disposal, having 15,000 brokers that any investor can call anytime, makes a huge difference.

“I’m not sure why JPMorgan, Goldman Sachs have come up with earnings that beat estimates when you think of all the headwinds in our industry.

“Structured products are not a large business, but they offer huge profit margins.”

96% in equity

Equity-linked notes made for a stunning 96% of the total, compared with 72% the week before. The average for the year is 82.5%. Last year, 78% of the action was equity-based.

“It’s amazing that we’re in the middle of the summer and people are massively making bullish bets on equity,” the sellsider said.

“Everybody is jumping into equities; everybody is bullish. Momentum is what drives up the market. Even Goldman just raised their year-end targets for the S&P. Yellen continues to be unclear about the timetable for raising rates, but people figure that they’re going to keep them low for at least a good year. That leaves investors with the expectation that they can still profit from the rally, at least with short-duration notes.”

Irrational exuberance

Many investors may be bullish, but their outlook may not necessarily be aggressively bullish given the strong bid on enhanced return notes, he noted.

The proportion of leveraged notes with full downside risk exposure was above average last week at 53% of the volume. In contrast, leveraged products that offer either a barrier or a buffer nearly disappeared, with $15 million sold in four deals, or 3% of the total.

Usually those two types of structures are equally in demand, according to the data. For the year to date, for instance, leverage with no downside protection amounted to 16%, the same proportion seen for partially protected leveraged products. As a yearly trend, however, buffered or barrier leverage is up 6% while principal-at-risk leveraged notes have seen their volume drop by 12%.

“Investors want more upside, and issuers can’t price the downside. Add those two factors together and you’ll see more demand for pure leverage plays with full downside risk exposure. People are probably overly leveraged, and it may not end well,” the sellsider said.

The largest deal last week was one of the highly leveraged notes with a cap and no protection.

Barclays Bank plc priced $118.18 million of 0% Accelerated Return Notes due Aug. 28, 2015 linked to the S&P 500 index. The upside participation rate is 300% with a 10% cap. Investors are fully exposed to losses if the index declines. BofA Merrill Lynch was the agent.

“Unbelievable. No protection whatsoever. Irrational exuberance is back,” the sellsider said.

But the distributor argued that the appetite for leverage, even with no protection, is understandable.

“The vast majority of structured products are distributed by the private wealth management divisions of large banks,” he said.

“These distribution networks have knowledgeable advisers catering to high-net-worth clients who are equity buyers to begin with and who don’t mind having three times leverage on the upside for the exact same risk exposure they would get if they were to buy the equity directly. They see in those structures huge value.”

The second largest deal last week followed the same structure type with three times leverage on the upside and full downside exposure.

It was another Barclays offering, $72.91 million of 0% Accelerated Return Notes due Aug. 28, 2015 linked to the Euro Stoxx 50 index. The cap is 13.8%. BofA Merrill Lynch was the agent.

Barclays was the issuer of choice for Bank of America last week. It brought to marker the fourth largest deal, $51.51 million of 0% Accelerated Return Notes due July 22, 2015 linked to the common stock of Facebook Inc. Again the structure featured three times leverage on the upside, a cap, which was set at 31.2%, and full downside exposure.

“Indexes don’t pay anymore unless you go for a worst of,” the sellsider said.

“So now they leverage out a stock, and not just any stock. They picked one of the most volatile names out there. It’s amazing. Very soon, we’ll see worst-of [notes] based on a couple of stocks and not indexes. It’s a little scary.”

But the distributor disagreed on the view that investors buying notes linked to Facebook are more likely to be well-informed about the stock and the risks than buyers of notes based on the broader market.

“I like this one for instance if I had a client of mine infatuated with social media. Maybe that’s a stock he’s been in and out of a couple of times. If he thinks there is upside potential and if he’s comfortable having the same downside risk as the stock, why not? There is no dividend that you’re giving up. If the stock is up 20%, you make 30%. It’s a play on volatility in an environment where volatility is drastically low,” the distributor said.

Barclays issued a similar deal for $15.3 million linked to the Nikkei Stock Average index with a 12.5% cap. Also distributed by BofA Merrill Lynch, it was the sixth largest deal of the week.

No alternative

Market participants said that too much appetite for leverage with no buffers or barriers could spell trouble for retail investors if the market goes through a correction.

“As soon as the market hits new highs, that’s when people want to buy. That’s when your high-net-worth client can’t stand being in the golf course when their friends talk about their stocks and they’re not in,” the distributor said.

“I believe that at some point there will be a reckoning, but in the meantime people are buying more equity because there are no alternatives when you think about it. Rates are very low. Returns in other asset classes are just very hard to get.”

There was only one commodity-linked offering for $3 million last week. Agents did not price any rate deals, according to the data.

“Commodities have lost their appeal for a while. It’s even worse now with investors preoccupied with the Middle East and oil. Gold is still a hedge against inflation, but where is the inflation?” the sellsider said.

“And for the rates, it’s getting tougher. The spread for those CMS steepeners is tightening. Long rates are relatively stable, and rates on the short end of the curve have gone up. There aren’t many ways to keep on showing first-year rates at 9% or 10%, which is the only reason investors buy these products. They want the headline rate, and they make the assumption that they will be called, which may or may not happen. In order to be able to price those deals, maturities have to be significantly longer. We went from 10 years to 20 years. On top of that, it’s not just the spread between the 30-year and the five-year or between the 30-year and the two-year with some leverage. They have to add conditions, introduce range accrual features based on equity benchmarks; it’s not a good time to make those deals.”

Betting on the champion

Some investors continued to show interest in delta one product with a focus on the underlying. JPMorgan and Barclays each offered an issue linked to the DAX index, the German blue-chip stock market.

JPMorgan Chase & Co. priced $72.2 million of 0% return notes due July 23, 2015 linked to the DAX index. It was the No. 3 deal of the week.

J.P. Morgan Securities LLC is the agent. The notes track the performance of the German index minus an adjustment factor.

“Despite the recent fears with Portuguese banks, investors are still very bullish on Europe. They see this market as having more upside potential than the U.S.,” the sellsider said.

“Now guess what? It could have been a soccer bet. The client may have been bullish on Germany before even knowing that they would win the World Cup. After all, Goldman itself makes World Cup bets every four years.”

The notes priced on July 8. Germany won the World Cup on July 13.

Separately, Barclays Bank priced $28 million of 0% notes due Jan. 21, 2015 linked to the DAX index with the same tracker structure. Barclays was the agent.

“It could have been done for the same client. I don’t know. But these are typical access plays,” the distributor said.

“These deals are appropriate for some investors, corporations, pensions or any institutional investor that may not be allowed to buy the asset directly. If JPMorgan does it and they’re buying it as a Cusip permitted by their bylaws, that’s where the value is.”

“Irrational exuberance is back.” – A sellsider

“It could have been a soccer bet.” – A sellsider on JPMorgan’s notes linked to the DAX index

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