Goldman's leveraged notes with 77.5% trigger tied to S&P 500 offer alluring call premium

By Emma Trincal

New York, Dec. 18 - Goldman Sachs Group, Inc.'s 0% leveraged autocallable notes due Dec. 27, 2016 linked to the S&P 500 index offer better value if the autocall is triggered rather than held to maturity, sources said.

The notes will be called at 110% of par if the index closes above the initial level on the call observation date of Dec. 23, 2013, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called and the index finishes above the 77.5% trigger level, the payout at maturity will be par plus the greater of 110% of any gain and par.

Otherwise, investors will be fully exposed to any losses.

"The attractive part of this deal is the call. I like the autocallable feature. Having a 10% premium after one year even if the market is nearly flat, that's not bad," said Dean Zayed, chief executive of Brookstone Capital Management.

Complexity, barrier

The payout was less attractive if the notes were not called and held at maturity.

In such scenario, the final index value would either be negative but above trigger, in which case investors would receive their money back, or positive, which would generate a leveraged return at a rate of 1.1 without any cap, according to the prospectus.

The final scenario, should the barrier be breached, or should the index finish down by 22.5% or more, was losses from the initial strike with the potential for investors to lose their entire principal.

"I don't like the complexity and I think the barrier is not so attractive," said Zayed.

"The S&P did well this year and may continue to do so in the following year.

"But a 22.5% decline four years from today is not unlikely, given the fair valuation today plus the fact that we have lots of headwinds with earnings potentially down.

"My opinion would be different if the S&P was at 1000 now. But the benchmark is near its all time high. We may reach that next year. Looking at historical cycles, especially earnings, I can see another downturn as a real possibility.

"If the barrier was 50%, this would be a great deal. But I don't think 22.5% is enough.

"The upside is interesting, but it's more complicated than useful in my opinion," he said.

Dividend considerations

For Jonathan Tiemann, founder of Tiemann Investment Advisors, LLC, the 10% call premium was appealing and may just be what would entice an investor to buy the notes in the first place, in the hope of getting called away after one year with a 10% return. But if this scenario failed to occur, risks could be significant, he warned.

"At first glance the 10% call premium is interesting. But I'm not sure that 10% is a fair price for what you're giving up, which is the dividend and the liquidity," he said.

"If the S&P finishes up in one year, you get 10%. But there may be some upside risk if the benchmark is up by more than that. That's a consideration.

"If you don't get called, you're stuck for three more years and you're at an index level lower than the initial price by definition.

"What you give away in order to get this attractive 10% boost is four years worth of dividends and your liquidity," he said.

The S&P 500 dividend yield is 2.05% per annum, so investors are giving up an extra 8% return over the term.

Breakeven

Tiemann ran the following scenario:

He assumed that the S&P 500 price performance at the end of the four years was 25%. With dividends, a direct investor in the equity benchmark would pocket a 25% plus the 8% in dividends, or a 33% gain at maturity.

An investor in the notes on the other hand would generate, with the 110% participation rate, a 27.5% return. That would represent underperforming the benchmark by 5.5% without having the benefit of full liquidity, he said.

Tiemann was not convinced that the downside protection offered a substantial advantage.

"The 10% premium doesn't come close to paying me for the dividends although the downside protection could be valuable," he said.

"If I'm down 20% and get par, that's pretty good.

"But over four years, the 22.5% protection range is narrower than you think.

"The downside is sort of interesting, but to have a strong enough view in the market to think that the market could go down 20% but not down by more than 22.5%, that's quite a forecast!"

A big jump

The worse problem however lied with the upside, in his view.

"You'd get your breakeven between these notes and the S&P only in a very, very bullish scenario," he said.

The breakeven point, he said, would be at an 80% price return of the index over the four-year term, which is 20% per year on average.

"I would get 88% with the notes, which would replace my dividend," he said.

"But getting a 20% annualized return over four-years is not a very realistic scenario.

"It seems to me like this is another 'complexity for its own sake' kind of deal.

"Investors in this are taking a short-term bet in the hope that the market will be up in one year. But the lack of liquidity and the length should really be considered. To me, the potential gain is not worth what you're paying for," he said.

Goldman Sachs & Co. is the underwriter.

The notes will price on Dec. 21 and settle on Dec. 27.

The Cusip number is 38141GLB8.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.