Year-end issuance marked by flurry of reverse convertibles, Bank of America's ascendancy

By Emma Trincal

New York, Jan. 6 - The last two weeks of the year 2009 were characterized by scores of reverse convertible deals not necessarily large in size but very abundant in numbers. Another important trend for the last half of December was the prevalence of Bank of America Corp. as the top issuer.

U.S. dealers sold $1.15 billion structured products in 294 deals from Dec. 21 to Dec. 31, according to data compiled by Prospect News.

Trigger reverse convertibles made up 28.94% of the total volume, with $334 million. It is the great number of trigger reverse convertible deals - 179 - that was also significant, sources said, as it represented almost two-thirds of the total number of transactions.

These numbers suggest that reverse convertibles are popular among investors but also that issuers tend to bring them to market in small increments.

The largest deal of the period was a reverse convertible as well. On Dec. 28, Morgan Stanley priced $71.1 million of Equity LinKed Securities due June 29, 2010 linked to the common stock of JPMorgan Chase & Co. The six-month notes have an annualized coupon of 8%, which is payable monthly.

Pre-crisis and now

Commenting on the flurry of reverse convertibles, a structurer said, "My guess is that the product is making a comeback. It used to be 400 deals a month before the crisis in the U.S. It's gradually picking up. A lot of issuers are familiar with the product and distributors too."

This structurer added that market conditions may also offer a good entry-point for investors right now.

"I think investors believe that the market is not going to rally that much this year so they want to get at least some good income," he said.

Monthly coupon appeal

Perhaps the frequent income stream is also a big factor driving clients' appetite, this source added.

"A few years ago, most reverse convertibles in the U.S. used to pay a coupon quarterly. It's worth noting that offshore reverse convertibles still pay interest at maturity," this structurer said. "One of the reasons reverse convertibles in the U.S. are one of the favorites is because they usually pay monthly. It's a unique product. It pays a monthly coupon and it pays a high coupon. Both features are important to investors. The monthly payment is key, but of course people are very attracted to the high income potential as well."

A sellsider in New York said that the trend is very clear. "If you look at the domestic equity-linked market, 70% of it in general is reverse convertible," he said.

Small is big

But this source stressed that the ability of some dealers to launch many small deals rather than a few large ones may drive up volume as well.

"Some banks have the advantage to be able to issue in small increments, which they upsize later. That's why you have so many deals, which are not particularly big in size," he said. "But it adds up."

A look at the average deal size for all deals - not just reverse convertibles - shows some strong disparities among issuers.

Barclays for instance, which is in the third slot for the period, was the agent for $159 million of notes in 92 deals, which represents an average size of $1.73 million per transaction, according to data compiled by Prospect News.

By contrast, Merrill Lynch, which was No. 1, brought $362 million in 10 offerings, or a $36.2 million average size per deal. The agent in second place for the period, Morgan Stanley, brought to market 12 deals for a total of $216 million in proceeds, an average of $18 million per deal.

Limited choices

The sellsider said that investors, when picking a reverse convertible product, make assumptions regarding the underlying stock's future volatility. A reverse convertible product will perform better when its volatility declines because the odds of breaching the barrier are lower.

But this sellsider said that choices for investors remain limited.

"Most issuers look at ... the competition and they tend to all pick the same names based on their clients' demand. You see the oil companies, with stocks such as Chesapeake [Energy Corp.]; the high-tech stocks like Apple [Inc.]; and the financials like JPMorgan or Wells Fargo [& Co.]," he said.

The coupons are high in the United States, but other markets offer much more aggressive terms, he said.

"It's usually a one-year product at 10% with a coupon paying monthly or quarterly," this sellsider said of the U.S. market. "It's very different than Latin America, where you get a one- to three-month maturity with a 15% to 20% coupon. They can do that because they use emerging markets underlyings," he said.

Bank of America rising

Another trend of the last two weeks of 2009 was the dominance of Bank of America as the top issuer.

Bank of America, through Merrill Lynch, sold almost a third of the total issuance volume during the period. In contrast, Morgan Stanley brought to market 18.75% of the total. Barclays Bank plc priced 13.76% of the pie.

Bank of America also brought to market eight out of the top 12 largest deals, which ranged from $21.61 million to $71.1 million in size.

Sources said that Bank of America's leadership is becoming more visible. Bank of America's rank for the two-week, year-end period contrasts sharply with its position held for the entire year in 2009, where it held the third slot after Barclays and JPMorgan.

"Merrill Lynch in the past has been the biggest distributor of structured products. By joining forces with Bank of America, they've become a really big institution in the U.S. marketplace. They have their own distribution network and with Bank of America's distribution network, it's not surprising to see them being a top player again," the structurer said.

Happy ending merger

For the sellsider, this year-end achievement suggests that the growing pains of the merger between Merrill Lynch and Bank of America may have finally ended and that the new merged entity may now have reached its full potential in terms of structured products issuance.

"Bank of America does not have a structured products culture. They have imposed on Merrill risk management and procedures that have somehow slowed down the product-approval process. Merrill traders were used to doing products that after the merger had to wait a little bit longer to get approved. But now they're getting to a point where the merger process is finally up to speed. So you're going to see a pick-up in issuance volume from Merrill," the sellsider said.

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