Rich premium for Goldman Sachs' leveraged buffered notes linked to S&P 500 seen as drawback

By Emma Trincal

New York, Jan. 23 - Goldman Sachs Group, Inc.'s 0% leveraged buffered notes linked to the S&P 500 index offer attractive terms, but the premium price offsets most of the structure's advantageous features, advisers said.

The notes will be priced at 106.5% to 107.5% of par and are expected to mature 60 months after the issue date, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 1.72 times any index gain. Investors will receive par if the index falls by up to 20% and will lose 1.25% for every 1% decline beyond 20%.

"From a registered investment adviser's perspective, this amount of premium is not really an option," said Steve Doucette, financial adviser at Proctor Financial.

"To have the client pay up front 106.5 to get 100 at maturity isn't so great. ... That would show a 6.5% loss immediately because that would be reflected in the pricing. As we manage clients' expectations, we never want to buy at a premium that shows a 6.5% loss on their first statement. I have no idea why they would put that cost on the front end."

Because the structure offers 1.72 times leverage on the upside, the index would need to increase by at least 3.78% to 4.36% in order for investors to break even and avoid losing a portion of their investment, according to the prospectus.

Still, Doucette said that the upfront premium cost is a "deal-breaker" in his view.

Statement shock

"We've seen deals similar to this one but at par," he said.

"Granted, it's usually a 10%, not a 20%, buffer and it's not always on the S&P 500. We've done something similar on the Euro Stoxx 50, which is a bit more volatile. But still..."

"The index move is really what determines the price, not so much the fee they're putting up front. When the index is moving one way or the other, the value of the embedded option moves also, and it gets adjusted. On the other hand, the underlying price is not the only factor. The market could go up, and the note may not be fully pricing the move because you're very early in the note. That's the time value factor.

"In contrast, if we pay a premium, it's going to show right away on the performance reporting.

"Even if they use it as a fee, 6.5% or 7.5% is way too high. When we buy a note, we look at 20 to 300 basis points, and that's the maximum.

"I wonder why they would put such a big premium. I don't know who they are selling it to, but it wouldn't interest us."

Negative eye-catcher

The terms of the deal are "very attractive," but the cost is a "negative eye-catcher," said Matt Medeiros, president and chief executive of the Institute for Wealth Management.

"I like the S&P for the next five years. From a statistical perspective, I think it's very unlikely that it will finish in negative territory below 20%," he said.

"However, you could see a pullback. Just in the summer 2011 we had a 20% pullback because of the budget, even though the market recovered shortly after that. So it's still good to have a buffer because while unlikely, a 20% drop is not outside the question.

"Having the evaluation on a point-to-point basis is great too. And for that type of asset class, a 20% buffer is very generous.

"On the upside, I obviously like the 1.72 times leverage, especially with no cap. It's quite attractive.

"I like the terms. I like the underlying. I like the structure. However, the cost is a bit worrisome."

Investors in a note sold at a premium may get a lower return than if the notes had been purchased at par, and that return may be "substantially" lower, according to the prospectus.

"I'm assuming that they are pricing in volatility and that the borrowing cost for the issuer must be very high because it seems to me to be very expensive," Medeiros said.

"A 6.5% to 7.5% premium ... at this rate, it's a negative eye-catcher.

"I can imagine that the pricing of five-year options on this index would be high, or the cost of funds or both.

"But I would have to get a lot more information before I get comfortable with paying that much of a premium up front."

Goldman Sachs & Co. is the underwriter.

The Cusip number is 38147QFP6.

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