Pre-holiday week is worst of year so far; Goldman top agent; issuers strive for better terms

By Emma Trincal

New York, May 28 - The week ended Friday leading to the Memorial Day weekend turned out to be the slowest so far this year with only 58 deals totaling $125 million, a 76% decline from the prior week, according to data compiled by Prospect News.

Last week made for less than 0.8% of the year's volume, a level even worse than the first week of the year, which saw the pricing of $170 million, or 1.1% of the total.

In comparison, the top week of 2014 so far, which closed the month of January, accounted for more than $2 billion in volume sold in 303 deals, according to the data.

Slow May

May so far is not great, sources said, expressing a sentiment confirmed by the data. Agents have sold $1.28 billion this month as of the 23rd, a 21.5% decline from the same period in April.

Volume fell nearly 18% from a year ago compared to the $1.56 billion sold in May 1-23 of last year.

The year remains strong, however, if not thanks to May. Agents have sold $16.05 billion this year as of May 23, a 13.3% increase from last year, the data showed.

"Business is getting really bad. Rates continue to drop on both the short and the long end," a market participant said.

"I can only imagine more layoffs either before summer or in September. They may keep things on hold during the summer when business is flat."

A sellsider was not as pessimistic. But he said that volume is definitely a topic of conversation between firms and with their distributors.

"What I'm definitely hearing from other issuers is that May isn't a good month," this sellsider said.

"It's easy to see why. You just have to watch CNBC. It's obvious to people who work in the industry that when you have a directionless market, low volatility and low rates it adds up in the difficulty of creating and pricing attractive products. It's hard to catch investors' attention in those conditions," he said.

Some issuers said that May traditionally is slow as it marks the beginning of the summer. This sellsider disagrees.

"Looking back at May of last year, we didn't notice any significant drop off for us," he said. "In fact, May was OK last year."

Volume from May 1-23 last year was $1.56 billion, a 22% increase from the same period in April last year, according to data compiled by Prospect News.

In 2013, May was actually (for the entire monthly period) the second best month after January, the data showed. Last week's data, however, does not yet include the final week of the month, by far the largest.

But sources remain pessimistic, attributing the slowdown to structural factors.

"The biggest reason for this weak market is the market itself," the sellsider said.

"The low volatility/low interest rates combination is not good for pricing. You have to have a real catalyst at this point to have people driven to take some action."

Looking at the $125 million volume for last week, the market participant said, "It's ridiculously small. Really not encouraging."

Goldman Sachs No. 1

Goldman Sachs rose among its peers last week to price the three largest deals and take the top slot as agent of the week. Sources noted that it is not common to see Goldman Sachs leading. Agents such as Bank of America, JPMorgan or UBS are more likely to be the top players on any given week, they said.

But last week was quite different. Goldman Sachs priced $60 million in three offerings, or 47.96% of the total, according to the data.

"We haven't seen them making a particular push, but that's on our end. They may be getting bigger. We work with Goldman through Incapital. We haven't seen anything new or interesting in terms of different products, more innovative structures," the sellsider said.

"One thing that works well for them is the brand. Goldman Sachs is a highly recognized counterparty within the retail structure. They always get a fair amount of business from us.

"It's not the highest rated issuer on our platform, but we see demand due to their name and the level of comfort around that. The combination of their funding advantage and name recognition benefits them. Their credit is low enough and their reputation is high enough ... it's kind of a sweet spot. People are paying less attention to the credit rating and more attention to the brand. It works for everybody. Goldman gets to price more attractive deals based on the credit, and investors are bidding on those products based on the name."

"They have the private bank. They also have exclusive agreements with Incapital for certain payouts," the market participant noted.

The largest deal last week was Goldman Sachs Group, Inc.' $31.5 million of 0% notes due Aug. 26, 2014 linked to the Topix index. This agent prices this deal approximately once a month. The payout at maturity will be 99.705% of the sum of par plus the index return.

In the No. 2 offering, Goldman Sachs offered a buffered digital product combining a U.S. benchmark and a non-U.S. benchmark.

The issuer priced $21.62 million of 0% buffered digital notes due June 2, 2017 linked to an equally weighted basket containing the S&P 500 index and the MSCI EAFE index. If the basket return is greater than or equal to zero, the payout at maturity will be par plus the greater of the basket return and 10%. If the basket return is negative but not below negative 10%, the payout will be par. If the basket return is less than negative 10%, investors will lose 1.1111% for every 1% that the basket declines beyond 10%.

More FX

The third Goldman Sachs deal was in currencies, a relatively minor asset class, according to data compiled by Prospect News.

Currency-linked notes represented nearly 3% of the total last year as of May 23 in 76 deals. During the same period this year, the market share dropped to 1% of the total and the number of deals to 39, according to data compiled by Prospect News.

The $7 million Goldman FX deal offered a bullish bet on the dollar against a basket of currencies in the form of a contingent coupon note due May 28, 2019. The basket currencies were the euro, the Japanese yen and the Swiss franc, each relative the dollar.

"I haven't seen a lot of FX in a while," the sellsider said.

"Those trades are risky because you could be bullish on the dollar for instance on the view that rates are going to rise. But it's always a relative play. It's not just the dollar. You have to look at the other currency on the other side of the trade, which has its own jurisdiction and could move in unexpected ways relative to the dollar."

JPMorgan Chase & Co. also priced a currency deal, the sixth one on the list, with $5.2 million of contingent buffered step-up digital notes due Nov. 23, 2015 linked to the Mexican peso relative to euro.

Equity combos

One important trend seen last week was the use of several equity indexes in different regions or asset classes. Those products were offered either in the form of baskets or worst-of deals.

The fourth largest deal of the week, a worst-of note, was an example. JPMorgan priced $6.91 million of 0% autocallable notes due May 27, 2016 linked to the S&P 500 index and the Euro Stoxx 50 index. The notes will be automatically called at 12.25% per year if each index closes at or above its initial level on May 29, 2015 or May 24, 2016.

The payout at maturity will be par unless either index finishes below its barrier level, 80% of its initial level, in which case investors will lose 1% for every 1% that the final level of the lesser performing index is less than its initial level.

But issuers also used baskets such as Goldman Sachs in the No. 2 deal mixing the S&P 500 and the MSCI EAFE in equal weightings.

"We see combos in indexes because you can't do a simple S&P-linked note in the current environment. Volatility is too low, interest rates have come down even more," the sellsider said.

"In order to get better terms you have to start doing baskets or worst-of to get at least some correlation risk.

"If you put the S&P with the Russell, you add a bit of risk. The correlation is still high, but it's not 100%.

"And you can do that even better by mixing assets that are less correlated, U.S. and non-U.S. indexes for instance, such as S&P and the Euro Stoxx. We see that more and more."

Diversification purposes

The market participant said that if issuers want to boost returns and bring better terms, their best option would be to use worst-of notes, not baskets of indexes.

"I think issuers are selling those baskets because people ask for diversification. Firms are trying to offer an alternative to a mutual fund. Here is a global equity note: you have the S&P 500, the Euro Stoxx, the emerging markets. I think people want that," the market participant said.

But the sellsider said that the driver behind this trend is pricing.

"There is even more risk with worst-of than baskets, but people are doing both," he said.

"The idea is to introduce some correlation risk by adding together indexes that don't have a perfect correlation. By adding risk, you are able to get better economics, whether it is a better downside buffer, more upside participation or a higher coupon.

"You have to be careful not to push the envelope though by putting together things that are completely uncorrelated like the S&P, the Euro Stoxx and gold. With gold, which is completely uncorrelated to equities, sure you can bump up the return. But if it's a worst-of, you're taking a big risk.

"In most of those deals we're seeing lately, the risk is controlled. You get correlations in the 70% to 80% range, which is still relatively high."

Spreads

Rather than structuring worst-of or leveraged notes on a basket, the market participant said that issuers should consider "putting together relative value" trades.

"I wonder why we don't see spread deals in equity," he said.

"If the idea is to offer diversification while boosting the returns, why not putting together notes tied to the spread between two equity indexes? For instance, here's the Euro Stoxx, here's the S&P. Your return is linked to the spread between the two. You get paid on how much the European index outperforms the U.S. benchmark.

"People like the Euro Stoxx right now. They think there is more value in it than in the S&P 500.

"I don't know why we don't see more of these deals. I'm pretty sure they would be very popular."

The No. 2 agent last week was JPMorgan with $28 million, or 22.5% of the total, in 11 deals. It was followed by UBS.

"I can only imagine more layoffs either before summer or in September." - A market participant

"There is even more risk with worst-of [notes] than baskets, but people are doing both." - A sellsider

© 2015 Prospect News.
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