October’s structured products issuance strong thanks in part to Merrill’s early presence

By Emma Trincal

New York, Oct. 19 – October structured products issuance so far is strong with $919 million in 241 deals, more than twice the volume seen last month through Sept. 14, according to data compiled by Prospect News.

This robust volume is not due to last week’s action but to the prior week, which saw an unusually high volume at $662 million, with larger block trades.

The first half of the month is also much higher than a year ago, up 72.53% from $533 million.

If October looks so strong, last week in contrast was quiet and shorter due to the Columbus Day holiday.

Agents priced a small volume of $257 million in 99 deals, and the deals were small in size, according to the data.

Early Merrill issuance

It was among the six slowest weeks of the year. The calendar and the four-day week contributed to this lackluster volume, sources said.

Yet beyond size, the presence of BofA Merrill Lynch was intriguing, sources said.

This agent was second in rank with nearly 20% of the volume, an oddity as the firm typically prices most of its business in the final week of the month.

While the “pie” was small, BofA Merrill Lynch as a distributor grabbed a sizable slice, they noted.

It may have been because the overall week was slow or it could be the result of a change in the giant agent’s distribution pattern, although sources said they were unsure whether it was the case.

Merrill Lynch did create a precedent this year when it chose to postpone its late June pricing into early July. But it had a reason for doing so as it sought to avoid the anticipated volatility the Brexit referendum would induce, according to sources.

“Sometimes [Merrill] has discretionary accounts and they can’t issue it themselves. They’re putting it out for bid, they roll the existing account and add some other accounts. They want to keep it in another schedule than the monthly cycle,” a market participant said.

“You could also have a quarterly roll. Stocks deals can be one-off driven by research.”

BofA Merrill Lynch prices index-based notes for the most part. It is by far the top agent in this asset class with about a third of the year-to-date volume. But it also distributes about 15% of the single-stock market, according to the data.

Last week, Merrill Lynch sold $9 million of one-year Canadian Imperial Bank of Commerce notes carrying a 7.16% fixed rate and linked to Facebook, Inc. with a 5% buffer and quarterly interest payments.

The agent’s largest deal – and the second in size last week – was also issued by CIBC. The price was $19.55 million. The leveraged buffered structure tied to the S&P 500 index offered a 200% upside participation rate up to a 9.3% cap and a 5% buffer on the downside.

Opening distribution

It is possible that Merrill Lynch may be spreading its distribution more evenly through the month, an industry source said.

“They’ve signed some agreements with other distributors,” he added.

“They have large funding needs. They can’t only fund themselves. Sometimes they use wholesalers. They’re not alone in doing that by the way. Goldman uses Incapital for its distribution.”

Merrill Lynch has an open architecture platform using a number of issuers, including HSBC, Barclays, Deutsche Bank, Credit Suisse and others, he noted.

“There’s the need for customers to diversify the paper. But there’s also a secondary market redemption issue. You can’t have a bank issue debt and they purchase that same debt bringing back the assets on the balance sheet. It negates the purpose of funding. It’s circular,” he added.

He was referring to Bank of America, the issuer.

But apparently, the firm is now tapping into other brokers or wholesalers to enhance its distribution capacity.

“It’s not just the funding that they need. They need the underwriting and derivatives flow and they need transactions to get those flows. When they have tapped everybody in their network – their retail network, institutional network, private wealth – they go outside and find other counterparties, other distributors. It’s all about increasing their breadth,” this source said.

The market participant said that it was possible to see Merrill Lynch expand its distribution effort to third parties. But he did not think it would be a strong or lasting trend due to obstacles the giant distributor faces in the market.

“It’s difficult for them. They’re so successful as the biggest wealth management firm in the country, a lot of brokers don’t want to show Merrill’s products to their clients. It’s like advertising for Merrill Lynch. At every corner in America they compete with boots on the ground with the Edward Jones, the Raymond James. They’re the biggest distributor in the U.S.”

Income prevails

Almost half of the volume last week – $134 million in 64 offerings – came from autocallable reverse convertibles in a sign that the thirst for income is still a robust trade despite recent increases in interest rates. Many of those products, or 70% last week, were linked to indexes. Single-stock deals in this structure were much smaller in size.

Last week’s volume in equity-index-linked notes across all structure types was two-thirds of the total.

Unusual structure

The top deal for last week was unusually small, just above $20 million.

The structure was relatively “exotic,” according to the industry source.

Royal Bank of Canada priced $20.21 million of five-year contingent coupon buffer enhanced return notes linked to the S&P 500 index.

A contingent coupon of 4.65% a year was payable if an 85% barrier (knock-in) was not breached on any day. At maturity, in the absence of a knock-in event, investors received their principal and final coupon. If a knock-in occurred, the payout was par plus 117.65% of the sum of the index return and 15%. As a result of this calculation, the payout would be more than par if the final index level was above the barrier and less if the final index level was below it.

“I’ve seen these before. I don’t know how successful they’ve been,” the industry source said.

“They have a complicated downside scenario.

“I just find it remarkable that these pretty esoteric structures can sell.

“The coupon is not that attractive but you have the upside potential at maturity with possible gains on the downside if you’re above the barrier.”

The top agent last week was JPMorgan with $59 million in 13 deals, or 22.85% of the volume. Bank of America was next with $50 million in five offerings, or 19.30% of the total. The third agent was HSBC with $35 million.

The year-to-date picture is still negative, but an improvement is noticeable compared to a few months ago.

Agents so far this year have priced $29.06 billion compared to $34.94 billion last year, a 16.85% decline.

“I’ve seen these before. I don’t know how successful they’ve been. They have a complicated downside scenario. I just find it remarkable that these pretty esoteric structures can sell.” – An industry source, commenting on Royal Bank of Canada’s five-year contingent coupon buffer enhanced return notes linked to the S&P 500 index

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