GS Finance’s autocall linked notes on SPDR S&P Bank ETF fit sideways, bullish view on banks

By Emma Trincal

New York, July 27 – GS Finance Corp.’ autocallable index-linked notes due Aug. 3, 2023 tied to the SPDR S&P Bank exchange-traded fund present a structure that may accommodate both mildly and strongly bullish investors, advisers said. Unfortunately, the pure leverage bull play has its limits in time since the trade only has one year to be deployed starting at a negative price.

The notes will be automatically called at par plus 9.7% if the ETF closes at or above its initial level on Aug. 12, 2022, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called and the final level of the ETF is at or above its initial price, the payout at maturity will be par plus double the return of the ETF.

If the ETF falls by up to 20%, the payout will be par. Otherwise, investors will be fully exposed to the decline of the ETF from its initial price.

The final level will be the average of the index closing prices of the five trading days preceding the maturity date.

Leverage, no cap

“This one is a little bit more complicated,” said Kirk Chisholm, wealth manager and principal at Innovative Advisory Group.

“The 9.7% return on the call is reasonable for the first year. If you have a flattish, sideways view, it’s not a bad play.

“But I’m not too thrilled about the second part of the structure – when the notes mature.”

At maturity, the ETF share price needs to rise sufficiently to provide a robust return, he said. But for Chisholm the risk was too great on the downside.

“The challenge if the notes are not called is certainly the barrier,” he said.

“There’s some downside risk for banks.

“The two-times leverage with no cap is great if you’re bullish. But I don’t expect much upside, so it doesn’t do anything to me.”

Yield curve dependent

In general, bank stocks are not among the most volatile securities, he noted. The call scenario, which can materialize in a sideways market if the price is flat or slightly up, is the most appealing, he said.

“Banks are not interesting when it comes to the upside. It’s not an exciting asset class,” he said.

Bank returns are also too dependent on the direction of interest rates, which has confused market participants this year.

“If rates go up, if the yield curve steepens, that will be good for the banks. But right now, we’re not seeing that type of scenario. Right now, banks are not lending,” he said.

Downside risk ahead

A market sell-off such as last year’s Covid-19 induced bear market in March could push prices down 35%, he noted.

“There is no buffer. It’s just a barrier and it can be breached. This 20% protection doesn’t protect you at all,” he said.

The leveraged payout, which can only happen in the absence of a call on the one-year observation date, requires the fund to rebound from a negative level. Investors expecting to benefit from the leverage are betting on a strong and fast recovery within the second year.

“If we have a severe downturn, I don’t necessarily think the market will come back like last year. The speed of last year’s rebound was very unusual. It’s not likely to happen again,” he said.

Two in one

Jonathan Tiemann, president of Tiemann Investment Advisors, said he was not sure what the investment theme of the notes was about.

“It’s a bit odd. The structure is not that complicated. But it’s hard to see what people are really betting on. You almost have two deals in one. I’m not sure who would want this,” he said.

The uncapped leveraged upside was appealing on a two-year term. But it was an unlikely scenario, which depended mostly on interest rates, he noted.

“You’re betting on interest rate rising quite suddenly after the first year because bank stocks tend to rise with interest rates. But if you want the leverage with no cap, rates have to spike on year two,” he said.

Investors may also have a mildly bullish outlook for the first year, hoping to be called to pocket the 9.7% premium.

“That wouldn’t be bad,” he said.

“It’s really a combination of two different bets. The first-year bet is a range bound, slightly bullish bet. The second one is more bullish. You want bank stocks to jump in price during the second year.”

Inflation

Tiemann agreed with Chisholm: the payout was a function of interest rates.

“It’s a derivative on derivatives. Your return is tied to bank stocks. But bank stocks are influenced by interest rates.

“There are many different factors that cause bank stocks to go up. But higher interest rates are what people are looking at right now,” Tiemann said.

Rates should stay low for now and then jump, he said.

“I don’t know that I would expect rates to pop up.

“I’m in the camp of those who believe that we’re seeing higher prices because supply hasn’t caught up with demand in a lot of sectors of the economy.

“I don’t think it’s inflation.

“So, it’s hard for me to figure out what would be investors’ motivation for buying this note,” he said.

The notes are guaranteed by Goldman Sachs Group, Inc.

The notes will price on July 30 and settle on Aug. 4.

Goldman Sachs & Co. LLC is the agent.

The Cusip number is 40057HYY0.

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