Goldman prices $50.09 million trigger notes tied to S&P 500, its largest equity deal in 2010

By Emma Trincal

New York, Feb. 18 - Goldman Sachs Group, Inc.'s $50.09 million sale of trigger notes linked to the S&P 500 index, the firm's biggest equity transaction so far this year, suggests that investors may be looking for more defensive products as bullishness in equities has receded, sources said.

The 0% index-linked trigger notes are due Aug. 18, 2011, according to a 424B2 filing with the Securities and Exchange Commission.

If the index closes below 80% of its initial level on any day during the life of the notes, the payout at maturity will be par plus the index return, which could be positive or negative.

Otherwise, the payout will be par plus the greater of the index return and 13%.

In both cases, the payout will be capped at 130% of par.

Pluses and minuses

"As with any structured products, you have to look at the negatives and the positives. The negatives are that unlike a direct investment in the S&P 500, you don't get the dividends; you are exposed to Goldman Sachs' credit risk; and your returns are capped out at 30%," said Scott Miller Jr., managing partner at Blue Bell Private Wealth Management in Blue Bell, Pa.

"But on the positive side, if the market goes down by no more than 20%, you still make 13%. The S&P [500 index] could be down 10%, you would still make 13%. That's a pretty good investment," he said.

On the downside, Miller said that if the index went down in price by more than 20%, investors would be "slightly worse off" than with the index because they would not be receiving the dividends. "It's not a huge difference, but it's something," he noted.

Moving sideways

"These notes are a pretty good investment if you think there is not a lot of volatility in the market," Miller said. "A lot of people call for a sideways-moving market. As long as the index doesn't go down by more than 20%, it's a good investment. And if you think the market is going to be range-bound, this would be a good play."

The $50.09 million sale is Goldman Sach's largest equity-linked deal so far this year.

In January, Goldman, Sachs & Co. priced a series of bigger deals but in the currency sector such as the $90.91 million sale of 0% currency-linked notes due Feb. 28, 2011 linked to the Korean won relative to the euro on the behalf of Eksportfinans ASA. Overall, Goldman Sachs has done seven Korean won deals for a total of $172 million this year.

"They've done a lot of currencies so far, but I wouldn't read much into that. I wouldn't conclude that they're moving out of equity into currencies. Goldman is going to hit all asset classes," a distributor said.

However, the other equity-linked deals so far have priced at much lower levels than late last year.

Last month, Goldman Sachs sold $36.83 million of 0% leveraged equity-linked notes due Sept. 26, 2011 linked to the S&P 500. It was a distinct structure, however, involving 300% leverage and a 12.5% cap.

Smaller trigger deal

Late last month, Goldman Sachs brought to market another trigger notes deal also linked to the S&P 500 and with the same 18-month tenor. But the sale was much smaller in size - $20.71 million - and sources pointed to important structural differences that may or may not explain the difference in proceeds.

The deal that priced in Jan. 29 featured a structure with a thinner barrier of 85%. The contingent minimum return was 2.53% rather than 13%. However, unlike the new offering, this earlier structure was not capped.

In addition, the earlier deal bases the payout at maturity on whether the final index level breaches the barrier instead of whether the barrier is breached during the life of the notes.

More risk aversion

"The recent one is more conservative: you have a higher minimum and less barrier risk," the distributor said.

"The only conclusion one could draw when comparing the size of these two deals is that people are becoming more conservative. The reasoning would be: I'll take a cap but give me more minimum return. While some people think we are moving toward a recovery, a lot of investors are a little bit more risk adverse."

"If you believe, as I do that we'll be in a sideways-moving market, if you're slightly bullish but not too bullish, you're going to prefer the most recent deal with the cap but a higher minimum return. The other one, the uncapped deal, was a play for those who are very bullish," said Miller.

Low volatility expectations

Miller said that it is almost impossible to interpret the reasons why a deal would be much larger than another one, just based on its structure. "Sometimes, it's hard to tell. One client may be a large investor or a hedge fund for instance, and they would be making a much bigger trade than the other. Without knowing who is buying, it's hard to draw any conclusions," he said.

"The reason why people would buy into the deal that offers a 13% contingent minimum return is because these investors expect a sideways market, so they can make 13% in a market that is slightly up or slightly down. These investors went for a much higher coupon because they think the market is going to be flat," Miller added.

Unsurpassed autocallables

Even at $50 million, the recent S&P 500 deal remains much smaller than some of the noteworthy equity-linked products Goldman Sachs brought to the market late last year.

In particular, nothing seems to match Goldman Sachs' sale in November of $346.8 million of 0% autocallable index-linked notes due Aug. 19, 2010 linked to the S&P 500 index.

The notes are automatically callable at par plus 7% if the index closes at or above 107% of its initial level on Monday of any week, an outcome that is desirable for investors as it gives them an opportunity to get their principal sooner and earn a high coupon.

Minimum return appeal

This autocallable structure shared a similarity with the recent trigger notes: It included a contingent minimum return investors can expect to earn as long as the barrier is not breached at any point during the term. In the autocallable structure, if the index never closes below 85% of its initial level, the payout at maturity will be par plus the greater of 6.6% and the index return.

While the autocallable and trigger notes are two different structures and not comparable given their differences in duration or terms, sources said that it's natural for investors to seek deals with a high contingent minimum return when they believe the market will trade range-bound.

Goldman, Sachs & Co. is the underwriter with J.P. Morgan Securities Inc. as co-agent.

Fees are 1.4%.

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