Issuance rises 53%; volume driven by large stock deals sold across diversified structures

By Emma Trincal

New York, July 20 - Volume increased by 53% last week to $463 million. It was helped by a pick-up in volatility and an outpouring of large deals linked to single stocks and sold under a variety of structures, according to data compiled by Prospect News that excludes exchange-traded notes.

For the month, volume slowed down to $916 million, a 3.5% decrease from the first half of May. However, issuance this year to date continues to be ahead of last year at $24.36 billion, up 10.5% from last year.

"The pick-up in volatility certainly helps volume," said Brad Livingston, vice president at the Income Solutions Group with Capital Guardian LLC.

"But a lot of that [volume] has to do with the distribution channels. You could have either big lead orders or a lot of products from last year maturing and being rolled over."

Equity interest

Investors returned to equity with a strong preference for stocks over indexes.

Equity notes represented 70.5% of the volume, above the 66.5% share for the year to date.

Equity-linked notes rose by 61% from the week before to $326 million. The bulk of this growth came from stocks, which grew 78% in volume and totaled $247 million, 53.5% of the total.

In contrast, products tied to equity indexes made for only 17% of the total with $79 million sold, a 52% increase from the week before when the trend was already visible with $52 million sold at the time.

The year-to-date market share percentage for equity index-linked products is 35%. It is 30% for stocks.

"Index deals have taken a step back as clients are trying to reassess their portfolios," a sellsider said.

Five out of six

Among the top six deals last week, five were linked to single stocks including the top two.

"Individual stocks deals prevailed at least in terms of size," the sellsider said.

"That's because people don't necessary have a view on the market as a whole.

"The broad indexes like the S&P 500, the Nasdaq are out of favor for now because people are uncertain about the market direction."

The CBOE Volatility index, or VIX index, which measures implied volatility on S&P 500 options, was up 6.2% last week, peaking on Thursday above the 20 milestone at 20.80.

The VIX has gained momentum since its 15.95 close on July 8.

"I think a surge in volatility is good for stock deals. It gives investors better terms and higher coupons," said a market participant.

Hybrid structures

The most popular structures were not the traditional reverse convertibles or leveraged notes. Rather, the most popular offerings reflected an appetite for different structures aimed at giving investors more yield.

"We're seeing those hybrid structures due to the uncertainty of the market," the sellsider said. "Income has been king over the last six months."

The two top transactions were sold by Bank of America Merrill Lynch with a structure very popular in the firm's distribution channel, the STEP Income Security.

Barclays Bank plc issued both products, which has been the case several times before for those STEP Income deals, according to data compiled by Prospect News.

The No. 1 deal was Barclays' $70.28 million of 7% STEP Income Securities due July 27, 2012 linked to the performance of General Electric Co. shares.

If the final price of GE shares is greater than or equal to the step level - 107% of the initial price - the payout at maturity will be par of $10 plus 7.11%. If the stock finishes at or above the initial value but below the step level, the payout will be par. Investors are fully exposed to any losses.

Barclays' $38.36 million of 11.5% STEP Income Securities due July 27, 2012 linked to the common stock of MGM Resorts International, the No. 2 deal, have a step level of 111.5% and a 5.57% step payment. The downside threshold level is 95% of the initial price.

Merrill Lynch prices an average of three STEP Income deals per month, according to data compiled by Prospect News, most of which have been large in size.

Barclays' GE-linked issue is the largest STEP Income deal sold by the agent since March when it priced a $185.75 million STEP Income offering linked to the common stock of Ford Motor Co. on behalf of AB Svensk Exportkredit.

"I think this is probably a product Merrill Lynch has been pushing for a while. They're in the habit of explaining it to their clients, the good and the bad, and the client is comfortable with it," an industry source said.

Three on Morgan Stanley

The third, fifth and sixth deals were from Deutsche Bank AG, London Branch, which priced three 0% capped knock-out notes all due Aug. 7, 2012 and linked to the common stock of Morgan Stanley. JPMorgan was the agent.

The largest of those three priced at $20.07 million. The payout at maturity depends on the occurrence of a knock-in event defined as the shares of Morgan Stanley closing down beyond a 25% threshold anytime during the life of the notes. In such case, the payout will be par plus the stock return. If no knock-out event occurs, the payout will be par plus the greater of the stock return and 13%. In each case, the return is capped at 30%.

The second capped knock-out issue priced at $18.56 million. The knock-out level is 80% of the initial price, the minimum contingent payment is 20%, and the cap is 30%.

The third one priced at $17 million. The structure has a knock-out level of 80%, a 24% contingent minimum payment and a 30% cap.

"I love these structures," said Livingston. "What I love is that the stock can go down 24.99% and the client receives 20%.

"There's a huge window where you can do a lot better than the stock, and in the worst case, you have the same return as the stock.

"You're not going to lose any client over that."

Reverse convertibles stay down

With volatility on the rise and investors seeking income, some market participants may expect an improvement in the pace of reverse convertible issuance. But it was not the case last week. Only $30 million of reverse convertibles hit the market, accounting for 6.5% of the total. This was down 46% from the week before when those deals amounted to 18.5% of the issuance.

"I think it works both ways," said Paul Weisbruch, vice president of options sales and trading at Street One Financial, commenting on the impact of volatility on these structures and pointing to last week's sell-off.

Weisbruch explained that higher levels of volatility may scare away reverse convertible investors who are short a put to obtain a protective barrier. Once the barrier is breached, investors are forced to buy the shares.

"When you sell puts in a volatile market, yes you get a nice premium and it's a positive environment to sell puts," he said.

"But some investors don't have any threshold for any kind of pain at all. So I suspect they wouldn't do anything because they can't stomach the loss."

Another sign of risk aversion was the retreat of leveraged deals with no protection, down 32% at $30 million for 6.5% of the total versus 14.5% the week before. For the year to date, these structures amount to 19% of total volume.

Bank of America Merrill Lynch was the top agent last week with 33.40% of the market sold in eight deals totaling $155 million.

It was closely followed by JPMorgan selling 19 offerings for $150 million and 32.32% of the total. The third agent was UBS.

JPMorgan was the No. 1 agent the week before.

"Index deals have taken a step back as clients are trying to reassess their portfolios." - A sellsider

"I love these structures." - Brad Livingston, vice president at the Income Solutions Group with Capital Guardian LLC, on capped knock-out notes

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