Goldman grabs 50% of volume, bringing to market CMS, range accrual deals for yield seekers

By Emma Trincal

New York, May 29 - Issuance slowed during the week heading into the three-day Memorial Day weekend, with Goldman Sachs bringing half of the total volume in less-common structures, data compiled by Prospect News shows.

Agents sold $310 million in 92 deals during the week ended Friday, a 60% decline from the $760 million sold the week before.

Volume continued to be down on a month- and year-to-date basis.

The month as of May 25 recorded a 29% decrease in volume to $1.55 billion from $2.19 billion in the same period of April.

For the year, sales have dropped 15% to $14.10 billion so far from $16.59 billion last year, according to the data.

Goldman Sachs tops

Goldman Sachs sold approximately half of the entire market last week with $154 million in 15 deals, or 49.68% of the total.

Goldman Sachs Group, Inc. priced seven out of the top 10 offerings, including the largest deal: $33.59 million of 0% leveraged index-linked notes due Nov. 25, 2014 linked to the Euro Stoxx 50 index, a typical non-protected leveraged structure with a 1.42 leverage factor on the upside and no cap.

"It's not that common for Goldman to take such a lead," a sellsider said.

Goldman Sachs also priced two less-commonly seen structures: two of the issues were linked to Constant Maturity Swap spreads, giving investors access to a high fixed rate during the first year. The other pair consisted of range accrual notes with a pure equity underlying and no reference to Libor.

The first CMS deal, which priced May 20, was the No. 2 deal of the week, a $30.08 offering of 15-year callable quarterly CMS spread notes due May 23, 2028 linked to the 30-year CMS rate and the five-year CMS rate. The first year's fixed interest rate was 9%. After that, the coupon was four times the spread of the 30-year CMS rate over the five-year CMS rate minus 25 basis points, subject to a maximum rate of 9%. Interest was payable quarterly, and the payout at maturity was par. The notes were callable in whole at par plus accrued interest on any interest payment date after six months.

Two days later, Goldman Sachs priced the week's third-largest offering with another callable quarterly CMS spread note due May 30, 2028 also linked to the spread of the 30-year CMS rate over the five-year CMS rate. It was the same structure only with a lower first-year rate and cap of 8.5% instead of 9%.

Range accrual notes

Separately, Goldman Sachs priced $11.62 million of 10-year callable range accrual notes due May 29, 2023 linked to the Russell 2000 index.

The coupon was 8.25% multiplied by the proportion of days on which the index closed at or above the index trigger level, 75% of the initial level. Interest was payable monthly. The payout at maturity was par if the final index level was greater than or equal to 50% of the initial level. Otherwise, investors were exposed to losses from the initial index level. The notes were callable after one year.

The other callable range accrual product Goldman Sachs sold in the amount of $8.12 million was linked to the S&P 500 index and had a six-year tenor. Interest would accrue at 6.5% for each day that the index closed at or above an 80% trigger level. The final barrier was 80% as well. The notes were callable after one year.

"What seems to work for those CMS deals is that you have the opportunity for a high coupon. The teaser rates certainly help," the sellsider said.

"These are great yield opportunities. When you can get 8.25% or 9% on the first year, you're talking fairly high rates.

"If you look at the historical spread between the 30-year and the five-year CMS rates, you'd end up getting it most of the time.

"It's probably for a more traditional fixed-income clientele. Generally, fixed-income deals tend to be larger in size, they tend to be approved in more platforms. It makes people comfortable to have the full downside protection.

"Those CMS products are also particularly appealing from an access perspective. They give you exposure to something that you couldn't access in any other way, versus the S&P for instance, which you can easily get invested in through a fund. You wouldn't have the same payout as with a structured note. But you would have access.

"In fixed income, the alternative would be a plain-vanilla bond. With these CMS [deals], you get access to something entirely different."

Andrew Valentine Pool, main trader at Regatta Research & Money Management, said that the CMS deals and range accrual notes had one thing in common: "They're both used as income plays."

He added that the CMS products were not for everyone given their long maturity.

"We usually don't go more than eight years. And just after the first six months, it's callable a little too soon. If they call it right away, you don't even get the benefit of the full coupon on the first year," he said.

"I'm more interested in the range accrual types of deals, which are more equity-based. It may be 10 years out, but the 50% downside protection is attractive, and it's not callable in the first year.

"Those range accrual deals are probably more for RIAs because you do need to do the homework. You have to look at a chart and estimate how often the index is likely to fall by 25%, which would cause the interest to stop accruing. Most benchmarks are now hitting new highs. Say we have a pullback at 15%. The client still gets a pretty good coupon. A 25% decline over a long period of time is unlikely.

"Those deals could become popular for the deep barrier they offer. Fifty percent is nice. The structure allows investors to get a decent amount of protection while being able to get a good yield.

"For buyside shops like us, we always have the option to go to Goldman directly and ask them to put it at 98 or 99 or alternatively to give us better terms. Usually, we're able to get one or the other. If we don't get it at a discount, we may be able to obtain a lower trigger level, say 70% instead of 75% for instance. When the issuer deals with [an] end client where a commission is involved, they don't have much room to offer better terms. But we can."

Hybrid plays

The sellsider said that range accrual notes are less often seen than more traditional structures such as leveraged notes or autocallable reverse convertibles. But there is potential for more such deals, he said.

"These are pretty hybrid notes. It's not really fixed income. It straddles between the two markets. In the past, you had the fixed-income and equity markets very separate. Now you seem to have more and more products in between the two spaces, to a larger degree," the sellsider said.

"These [two Goldman Sachs range accrual deals] are still part of the equity space since returns are equity-driven and you don't have the Libor component."

Typical range accrual notes tend to be "dual" with an equity and rate component, both of which need to be in a range for the coupon to accrue. For instance, a standard dual range accrual note would offer an interest rate accruing at a specified rate for each day that Libor is below a certain percentage and the S&P 500 is above a certain barrier level.

Goldman Sachs' offerings only included the equity condition.

"Maybe those were sold to fixed-income buyers who like the structure, especially the 50% barrier, although the biggest thing for them is that they're not accustomed to principal at risk. A 50% protection isn't bad, but it's still not 100%. So this would be something the traditional fixed-income investor would have to watch out for," the sellsider said.

"It could be for a new kind of investor who is not thinking in terms of pure equity play or pure fixed-income play but rather wants to be in between and take the extra risk for some higher yield."

Indexes are back

Equity indexes dominated last week's market, with a greater emphasis on benchmarks other than the S&P 500 such as the Russell 2000 and the Euro Stoxx 50. Each of the latter two benchmarks appeared three times in the top 10 offerings.

"I can see that. The Euro Stoxx, the Russell, those have the most beta," Pool said.

"Europe has been beaten up and might do well. I don't see Europe faltering away.

"The Russell is made of smaller companies with more risk but also more upside potential."

Stocks declined from the prior week, making for less than 10% of the total, with the volume of equity-linked notes up 140% to represent 60% of the total.

However, for the month to date, single stocks continued to prevail at 41% of the total versus 28% for equity indexes, which is an unusual mix, according to data compiled by Prospect News.

For the year, the mix between stocks and indexes is 24% and 52%, respectively, but single-stock issuance so far this year is up 5% while equity index deals have seen their volume drop by 18%.

Last week's overall volume was tepid, sources noted.

There were no deals in excess of $50 million, compared with five issued the week before, according to the data.

For many, the slow volume was simply the result of the market run-up.

"The market is high, and we have a hard time finding reasonable entry points," Pool said.

"If we got a 10% pullback, we would be pretty happy. Most of the time, it's more like a 2% drop and almost immediately, the market goes back up again.

"We have a decision tree that tells us what to do in terms of buying, holding or selling for each percent drop in the market. But we rely on a pullback, which so far we haven't really seen."

The sellsider noted that the month was not over yet.

"This week will be more indicative since it will be the last week of the month. The volumes seem to have been so far lackluster. We're not seeing so much activity, and I'm not sure if it's across the board or not. It will be interesting next week to see what the final picture will be for May," he said.

After Goldman Sachs, the second top agent last week was UBS with $50 million in 66 deals, or 16.13% of the total. It was followed by JPMorgan, which priced 31 offerings totaling $46 million, or 14.87% of the week's volume.

"What seems to work for those CMS deals is that you have the opportunity for a high coupon." - A sellsider

"The market is high, and we have a hard time finding reasonable entry points." - Andrew Valentine Pool, main trader at Regatta Research & Money Management

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