GS Finance uses S&P 500 Futures index to price income bullet note with growth features, buffer

By Emma Trincal

New York, Oct. 11 – GS Finance Corp.’s upcoming fixed-coupon leveraged buffered notes due April 20, 2026 linked to the S&P 500 Futures Excess Return index are one of the latest offerings designed to tap into the futures market to enhance pricing in the equity-linked note space. In this case, the unusual structure combines income and growth in a bullet note, a market participant said.

Investors will receive a coupon of 1.5% per annum, paid quarterly, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 1.18 times any index gain.

If the index falls by up to 15%, the payout will be par.

Otherwise, investors will lose 1% for every 1% decline beyond 15%.

“This reference asset, an index using the E-mini-S&P 500 futures contracts as opposed to the spot version of the S&P, that’s the innovation,” this market participant said.

This is not the first deal based on the S&P 500 Futures index Excess Return, he noted.

GS Finance and BNP Paribas have already priced several deals in this index. JPMorgan has been showing pricing to buysiders, sources said.

“There is a trend. Other issuers have done it or are working on it. My guess is that Morgan Stanley is next. This is a very new concept. By using this futures index you can get much better pricing in a conventional buffered structure,” he said.

Better optics

He said the same note, if priced on the S&P 500 index, would not be as attractive.

“If I wanted to replicate this on a two-and-a-half year note with the spot index, I would have no coupon. To keep the same 1.18x leverage I would have to cap it at 40%. The 15% regular buffer would turn into a 10% geared buffer.”

The buffer would have to decrease in size in order to get rid of the downside gearing and the upside leverage would have to be eliminated.

“I could do a 9% hard buffer, one-to-one on the upside, a cap of 50% and no coupon.

“Or you could do a callable at one year. But then you’re no longer talking about bullet note,” he said.

Compensating for risk

Those terms can be priced because interest rates are much higher, he said. The risks associated with exposure to the futures market adds more premium.

“There will be a drag on the performance of the futures index versus the spot because of the risk of rolling contracts on the futures curve.

“This is what gives you more optionality,” he said.

In other words, the additional risk allowed for the pricing of better terms.

“Since the S&P futures index is not going to perform as well as the spot index, the structure is going to compensate me. But is this structure compensating me enough? I believe it does,” he said.

“It’s a bullet. It pays a fixed coupon. It gives you a hard buffer, some leveraged upside participation with no cap. It’s relatively unique. I don’t recall having seen something like that since the financial crisis,” he said.

Interest rate vs. leverage

Brady Beals, director, sales and product origination at Luma Financial Technologies, was more skeptical. While he understood the benefits of using an equity futures index for the “optics,” he questioned the value of the fixed coupon.

“I don’t really see the benefit of paying you a 1.5% fixed coupon. You could have generated more leverage if you had removed the fixed payment. Fixed coupons in structured notes are very expensive. You don’t have much left to put in the upside participation and that leaves you with a 1.18 multiple, which isn’t huge,” he said.

The coupon rate is not high enough to even attract income investors, he added.

“If your objective is to get some income out of this structure, using the total return version of the index would have been a better choice,” he said.

He conceded that the S&P 500 Futures Total Return index, which incorporates dividends, may not create very attractive terms. But the possibilities offered with the S&P 500 Futures index Excess Return were not fully utilized, he said.

“The S&P futures index is a drag on your return. You want to close the performance gap with the S&P 500.

“With the fixed coupon, you’re taking out the main goal, which is to use the leverage to close that gap, to offset the drag on your performance,” he said.

The 1.5% coupon rate did not entirely cover the 1.61% dividend yield of the S&P 500 index.

“You’re not even making up for the loss of dividends.

“I don’t really see the value of putting the fixed coupon in there. More leverage would have been a much better option,” he said.

The notes are guaranteed by Goldman Sachs Group, Inc.

Goldman Sachs & Co. LLC is the agent.

The notes will price on Friday and settle on Oct. 18.

The Cusip number is 40057WF28.

© 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.