GS Finance to price callable quarterly CMS spread notes in pure rate play

By Emma Trincal

New York, May 29 – GS Finance Corp.’s callable quarterly CMS spread-linked notes due May 2024 allow investors to bet on a steeper yield curve without introducing in the structure any equity components.

The interest rate will be 7.75 times the difference between the 30-year Constant Maturity Swap rate minus the two-year Constant Maturity Swap rate, subject to a maximum interest rate of 12% per year and a minimum interest rate of zero, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par.

Beginning in November 2020, the notes will be callable at par on any interest payment date.

No range accrual

The upcoming steepener deal differs from most new issues seen so far this year as the underlying is solely a spread between two rates with no equity components.

Most deals this year consisted of spread range accrual notes linked to the least performing of two or more equity indexes. With durations of at least 10 years, these products usually pay a fixed, or “teaser,” rate on the first year or two. After that, the interest rate will be the teaser rate multiplied by the proportion of days on which each index closes above a specific barrier level while the CMS spreads has to simultaneously remain positive.

The upcoming Goldman Sachs deal appears to be the first one solely linked on a CMS spread without the range accrual feature, according to data compiled by Prospect News.

Term structure

“There’s been inversion on some parts of the curve but not everywhere. The spread between the 30-year and the two is not inverted yet. Right now it’s +26 bps,” a market participant said.

“So, if you were to hold the notes right now, you would get a 2% interest rate. Of course, you’re betting on a wider spread.”

Bonds have been rallying over the past few weeks, pushing yields lower, as a result of mounting trade tensions between the United States and China, which prompted investors to seek safe havens, he explained.

Some parts of the yield curve are inverted. The spread between the 10-year Treasury yield and the three-month bill for instance is negative by 11 basis points. The inversion of this portion of the curve has raised concerns as it is known to be a reliable predictor of a recession.

Spreads have tightened because investors are increasingly concerned about slowing growth in the context of the current trade war. Meanwhile, inflation is still contained, he said.

The view

Some investors find pricing on steepeners more attractive when spreads tighten.

“People think it’s a precursor of a recession. We don’t. But this is a view,” he said.

“For the spreads to widen, the Fed needs to cut rates in the short-term, which might happen. After all, the futures market is pricing the odds of a cut in that direction.”

The futures market puts a 63% chance on a Federal Reserve rate cut in September.

On the long-end of the curve, a steepening of the curve would require investors to embrace risk again, in a reversal of the flight-to-quality trade.

“It’s not a bad deal. The 12% cap is far away. It’s no problem. For the leverage, I’ve seen better multiples, but it’s OK.”

Indication of interest

Matt Rosenberg, sales trader at Halo Investing, said those CMS spread deals have caught the attention of some of his clients.

“We’ve seen an uptick in interest maybe not in transactions yet but people are inquiring about these types of trades,” he said.

“The curve has been flat for a long time and some people see an opportunity,” he said.

With the notes callable after 18 months, the holding period may be a much shorter time than five years.

“If the curve moves up, you’re going to collect a pretty great coupon at least for 18 months. If it really moves up you will be called,” he said.

“There is no teaser rate but the multiple is nice. It makes sense if you’re willing to take on yield curve risk.”

Opportunities in secondaries

Rosenberg, however, said that he has seen more compelling deals on the secondary market.

“Halo looks to provide secondary liquidity especially for sellers,” he said.

“The secondaries for fixed-income are more readily available.

“If you’re a retail client looking for fixed-income, you might be able to find something attractive at 75 cents on the dollar with some upside.

“There’s an argument to be made for buying secondaries if you’re looking at this type of structure.”

The notes will be guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the underwriter.

The notes will price and settle in May.

The Cusip number is 40056FK20.

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