Year starts on quiet note; volume up only 4.5%, but more big deals hit the market

By Emma Trincal

New York, Jan. 12 - The year kicked off in a quiet mode, up only 4.5% from the last week of December, but the deals coming to market were larger in size, preliminary data compiled by Prospect News showed.

"There are so many changes in the market. We're in a wait-and-see scenario," a structurer said.

Moderate pace

The total volume was $726 million, slightly more but not significantly higher than the $695 million sold in the final week of 2010. This figure excluded an additional $3 billion of exchange-traded notes Barclays Bank plc put on the shelf for its popular iPath S&P 500 VIX Short-Term Futures ETN series, which has now reached the $20 billion milestone.

Activity was seen as moderate for a New Year compared to a year ago, when volume between the last week of December and the first week of 2010 increased by more than four times to $661 million, excluding another $1 billion ETN pricing by Barclays that also printed on the first week of the year.

"Last week was extremely quiet. It's not just the beginning of the month. It's the beginning of the year," a New York sellsider said.

He added that both December and January are sluggish months in general.

"We get paid for February to November, not December and January," he said.

"In December, banks prepare their budget. Nothing goes on. And in January, people are waiting for their bonuses. It's very quiet."

Higher swap rates

The structurer pointed to fundamentals that may have added to uncertainty.

"There are some changes in the market, and it has an impact on volume," he said.

"Swap rates are coming back up since their lowest point last summer. They're reaching their levels of December 2009.

"The European sovereign crisis is changing credit spreads all across the board, and banks are willing to pay more for debt.

"Some issuers are sitting on the sidelines. People are waiting for a better environment for issuing products."

This structurer explained how higher swap rates affect pricing.

"Swap rates are used to price any note. Higher swap rates allow for better products," he said.

"For fixed-income products, higher swap rates give you higher coupons.

"But it's also used for the packaging of index products: the higher the swap rate, the higher the participation."

More indexes

Data confirmed the appeal of index-linked notes, which rose last week while stocks were down.

The volume of products linked to equity indexes more than doubled last week to $217 million, or 30% of the total, from $89 million the week before, which was 13% of volume.

At the same time, stocks retreated, losing the popularity they had gained when the year closed.

Agents priced $338 million of stock-linked notes, a third less than what was sold the week before. However, the size of stock-linked offerings - as other notes pricing last week - was much bigger.

Only 18 single-stock deals hit the market, representing 47% of the volume, versus 119 deals the week before, or 72% of the prior week's issuance total.

Big deals

In general, deals were bigger last week. Agents priced four deals in excess of $100 million (excluding the Barclays ETN) versus none the week before. The average size grew to $17 million from $4.5 million.

"We saw large deals, enormous sizes for a New Year," said the sellsider.

"These $100 million deals are stuff for internal distribution. It goes to the private banks, the JPMorgans and the Smith Barneys."

Reverse convertibles slowdown

Reverse convertibles and autocallables plummeted last week, a result consistent with the decline seen in single-stock offerings.

Only eight reverse convertibles priced for $16 million, compared with $400 million in 111 deals the week before.

For autocallables, agents priced a meager $9 million in three deals, a strong decline compared to the $115 million sold the week before.

"We've slowed down our reverse convertible business ourselves, but it's generically the case early on in the month," the structurer said.

However he also attributed the trend to more fundamental causes related to pricing.

"I think it has to do with the European debt crisis. People are looking at debt with more caution, thinking 'I'd better wait until this thing blows away,'" he said.

"It's a debt-market trend, but it also applies to reverse convertibles."

Coupons, not buffers

The top deals of the week had one common trait: They did not include buffering. They offered investors either a high coupon or some leverage but without any downside protection. In most cases, returns were also capped.

An example was the top deal of the week (after Barclays' ETN), a leveraged return structure with no protection on the downside. It was Barclays' $106.3 million of 0% return enhanced notes due Jan. 25, 2012 linked to the S&P 500 index. The leverage factor was two, and the cap was 19.3%. Investors were to share in any losses. The deal was distributed by JPMorgan.

Another example was a series of deals that offered no downside protection but gave investors the benefit of a high coupon over a one-year term. The return was capped, but it was paid in addition to the coupon and based on the performance of the underlying stock.

Barclays for instance priced two separate $100.01 million issues of 7% Yield Enhanced Equity Linked Debt Securities due in January 2012. The pair represented the second- and third-largest offerings.

In one of the two deals, the notes were linked to the common stock of Cisco Systems, Inc. The payout was the stock return capped at 15%. In the other offering, which had the same duration and coupon, the underlying stock was Intel Corp. and the cap was 16.8%.

"Cisco is pretty volatile, and if you cap the return of a volatile stock, it becomes cheaper to structure," said the structurer.

"With higher swap rates and a more volatile stock, you can afford the structure. The swap rates give you money to spend, and the cap makes for a cheaper option."

But for some, this type of structuring may not be advantageous to investors.

"People are really taking risk. Betting on Cisco or Intel with no protection? I would understand it with Apple but not Cisco," said the New York sellsider.

"By forcing investors to give up protection, the issuer reduces its cost. Throwing in a higher coupon is less expensive than putting a buffer," he added.

The fourth-largest deal followed the same formula - a coupon plus a capped payout linked to a stock without any buffering. It was Citigroup Funding Inc.'s $100 million of 9% synthetic buy-write notes due Jan. 17, 2012 linked to the common stock of Freeport-McMoRan Copper & Gold Inc. The payout at maturity was tied to the share price return, payable in either shares or cash at the holder's option and subject to a maximum return of 25.25%.

Barclays was the top agent for the week, followed by JPMorgan and Citigroup.

"We get paid for February to November, not December and January." - A New York sellsider

"People are waiting for a better environment for issuing products." - A structurer

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