Structured products house of the year: Goldman Sachs

Patrick de Nonneville

Assuming no change at the Federal Reserve’s month-end rate-setting meeting, February will be the fiftieth straight month in which the central bank has held its target rate at 0%. That’s a continuing headache for investors, which has been intensified by the shrinking ambitions of structured product issuers.

Capital, liquidity and risk management concerns are behind much of this, but in the case of callable bonds, the problem is an accounting rule change that requires the issuer to mark the debt to market, including the impact of changes in its own creditworthiness. As a result, when the issuer’s credit spread tightens, increasing the value of the liability, it leaves the dealer with a paper loss – and that has driven many firms to stop issuing or scale back.

Goldman Sachs is an exception, thanks to its ability to match up issuance with another business unit that needs funding of that expected maturity and also accounts for it on a mark-to-market basis – the result is that spread tightening will cause a loss for the bank but also an exactly offsetting gain. It sounds a simple trick, but depends on the bank’s ability to find internal demand for funding that matches the maturity of the bond – and because the bond is callable, the expected maturity changes as interest rate forecasts change, potentially requiring reallocation of the funds.

“In the past couple of years, issuers have limited the volume of some popular structured products because of accounting factors and an inability to manage variable funding. Goldman Sachs has been able to maintain or increase issuance in this environment by developing a framework that centralises funding and liquidity risk management,” says Paula Madoff, head of North American interest rate products sales at the firm’s New York headquarters.

That was not straightforward, requiring co-ordination between a number of different groups within the bank, including the treasury, Goldman Sachs Bank, the legal team and the securities division. Those discussions enabled the firm to stay on top of the shifting funding profile associated with callable bonds – pricing them less conservatively than other banks as a result, Madoff claims – and gave it the confidence to expand its issuance.

As markets move, the expected maturities and exposures of our callable notes will change, and this funding picture is reflected in real time

“After we issue a structured note, the funding risk is transferred to a group that monitors sources and uses of funding within the firm on a real-time basis. This monitoring allows Goldman Sachs to optimise issuance of various kinds of debt, as well as the funding of assets around the firm. As markets move, the expected maturities and exposures of our callable notes will change, and this funding picture is reflected in real time,” Madoff adds.

This has allowed Goldman Sachs to remain active in callable and constant maturity swap (CMS) products while some competitors have quietly scaled back or pulled out altogether. That is appreciated by the bank’s clients, who also praise the firm for its willingness to customise products as well as the imagination and invention the structured products desk brings to its bespoke solutions.

“We have done a substantial amount of callable debt and callable retail notes across a number of term structures with Goldman Sachs to meet the needs of customers that are looking for yield in a very low-yield environment. They accommodated those clients by issuing paper up to 25 years out on the curve, which has been fantastic and has become the anchor in many fixed-income portfolios,” says John Radtke, chief executive at fixed-income underwriting and distribution house Incapital.

“There are some other banks offering callables, but their execution and flexibility is nowhere near as robust – and it’s Goldman’s emphasis on customisation and flexibility that really sets them apart. They worked with us to meet the needs of our customer base, whereas the more opportunistic banks will only offer the one structure the bank wants to do,” he adds.

This has helped cement the bank’s rapid – and recent – ascent to the top tier of structured products houses globally. According to internal data provided by Goldman Sachs, the firm’s interest rate-linked structured note issuance has exploded in the past four years – from just five deals in 2008, with a notional value of $31 million, to 207 deals as of October 2012 worth a notional $3.13 billion. Speaking to Risk in late November, the bank estimated it would have issued $4.4 billion in notional by the end of the year.

To put those numbers in perspective, data and analytics provider MTN-i ranked Goldman thirty-first out of 33 interest rate-linked structured note issuers in 2008 – last year, the firm took top spot.

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Structured products house of the year: Goldman Sachs

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