Reverse convertibles, leveraged notes dominate modest, early-cycle issuance

By Emma Trincal

New York, March 10 - Issuance was modest during the first week of March and featured a continued trend toward reverse convertible notes and leveraged notes as investors try to take advantage of possible higher returns in the equity markets, sources said.

Agents in the U.S. structured products markets sold $300 million in 49 deals during the week, an almost 85% decrease from the last week of February when $1.86 billion priced in 377 transactions, according to data compiled by Prospect News.

But the U.S. structured products market has a monthly cycle. The slowness of sales in the beginning of a new month is the norm, sources said.

25% in reverse convertibles

Dealers sold $70 million of reverse convertibles in 16 deals, which amounted to nearly a quarter of the week's total.

Barclays Bank plc was the dominant player in this category of products, contributing to nearly 90% of the issuance with $63 million in eight deals. In particular, Barclays announced the sale of six reverse convertible deals of $10 million each.

Following far behind Barclays was Royal Bank of Canada with approximately $4 million of deals.

Barclays leads

Funding costs may allow Barclays to pay higher coupons than other banks, a sellsider suggested.

"Barclays has tighter credit default swap spreads than Bank of America or Citigroup but wider spreads than other banks such as JPMorgan, which may allow them to create more competitive products," the sellsider said. "Barclays offers significantly higher coupons than other issuers on most of their reverse convertible offerings."

Another factor possibly explaining Barclays' leadership in reverse convertibles, a New York structurer said, is Barclays' integration of the North American business of Lehman Brothers last year.

"They've inherited Lehman's stock-trading platform, which was quite huge," the structurer said.

Selling volatility

The market is also a driving factor pushing issuance of reverse convertible products, sources said.

"While implied volatility has been going down so far this year, it really varies on a stock-per-stock, sector-per-sector basis," the structurer said. "You have certain stocks with a rising implied volatility. And the higher the volatility, the higher the coupon for the client," he said.

Banks issuing reverse convertibles may lower the cost of the option by selling it to a counterparty, this source said.

"The retail client sells volatility. He sells a put to the bank. The bank in turn can sell the put to a counterparty, a hedge fund, for instance," the structurer said.

Leverage wanted

Leveraged notes were the second most popular type of structure with $66 million priced in 11 deals, which represented about 22% of the total volume for the week.

Buffers are possible

Leveraged buffered notes are also attractive from a market and pricing standpoint, said the sellsider.

"For structurers, buffers are becoming possible due to the skew. Volatility varies depending on where your option's strike price is. It increases in parts of the curve and decreases in others. The skewed curve can help issuers with the financing of the options that are being employed to pay for the buffer," he said.

Buffered enhanced notes are also attractive to investors who expect more volatile markets and want to take advantage of the leverage, the structurer said. In most cases, those notes are linked to indexes, not single stocks.

"People like indexes because they're familiar with them. In addition, you see some clients who game the S&P 500 and who will wait for a big drop to enter the trade. If you have a note with a 10% buffer and if the S&P 500 drops by 10%, you get in, and you get an extra 10% cushion. If you're bullish, it's great. You get the added protection with two-times leverage," he said.

Bigger deals

The two largest deals last week were interest rate-linked notes.

"This is not surprising. Generally interest rates trades tend to be bigger, like Treasury bonds trade in bigger chunks than stocks do," said the sellsider.

However, even the largest deal at $45 million was small compared to prior periods, notably last year's fourth quarter when several deals in the $100 million size were priced weekly.

Morgan Stanley priced $45 million of leveraged CMS curve and S&P 500-linked callable notes due March 16, 2025.

Barclays sold the second largest deal with a $25 million issue of floating-rate notes tied to the Consumer Price Index due March 10, 2017.

Following those, Bank of America Corp. and Goldman Sachs priced two commodity-linked deals.

Bank of America sold $24.51 million of Accelerated Return Notes due July 5, 2011 linked to silver.

Goldman Sachs priced on the behalf of AB Svensk Exportkredit $23 million of floating-rate notes due March 22, 2011 linked to the S&P GSCI Index Excess Return.

Barclays led the issuance last week with $107 million priced in 15 deals, or 35.64% of the market share.

Morgan Stanley held the second slot with $54 million, followed by JPMorgan with $50 million.

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