GS Finance’s 18-month leveraged buffered notes linked to S&P 500 offer ‘balanced’ structure

By Emma Trincal

New York, Feb. 26 – GS Finance Corp.’s 0% 18-month leveraged buffered notes linked to the S&P 500 index should appeal to a wide range of bullish investors given the “balanced” terms of the structure, according to Suzi Hampson, structured products analyst at Future Value Consultants.

If the index return is positive, the payout at maturity will be par plus 1.5 times the index return, subject to a 17.5% cap, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index declines by 20% or less and will lose 1.25% for every 1% that the index declines beyond 20%.

Leveraged options

“The terms are pretty generous,” said Hampson.

“Your return can be as high as 12% per year, which is quite good. The buffer is very competitive. What seems to be a little bit different is the relatively low gearing.”

She explained that most leveraged notes can be divided into two different types that reflect different market expectations from investors.

The “bullish type” is based on a very aggressively bullish sentiment. Investors’ priority is to secure as much upside as possible with no cap or a higher-than-average cap.

“Those notes usually have a lower gearing because the investor believes the market will go up a lot,” she said.

The other type is geared toward the moderately bullish investors who anticipate a slow market performance. Those favor high leverage and are willing to accept a cap in order to obtain it, she explained. The same mildly bullish investors also tend to favor barriers or buffers, as they tend to be more defensive.

“Those investors are more cautious. They’d rather have some protection on the downside. On the upside, they’d rather increase the odds of making money rather than looking for a high return,” she noted.

On the other hand, the more aggressively bullish investors prefer a higher gain potential even if it comes with a lower probability of making money.

“This note is a bit of a hybrid. The 1.5 leverage multiple is not much; at least it’s not much for a note that has a cap. Capped notes can have two, three, sometimes five-time leverage. Usually when there’s a cap you expect a significant level of return enhancement,” she said.

“But I think in this case, you have a pretty high cap. A 12% a year return potential is quite attractive in this market environment. So you could still fit the strongly bullish profile given that the cap may not be easily hit.

“At the same time, the product offers a strong, hard buffer on the downside, which may attract other bulls with a more modest outlook.

“The result of all this is that we end up with a pretty well-balanced structure. There is something in there for everyone.”

Risk

Future Value Consultants assesses risk, risk-adjusted return and value for each product. It compares the note with two different averages, same product type and all products recently rated. This note belongs to the leveraged return category.

For the risk, the firm calculates the market risk and the credit risk. It adds the two components to generate the “riskmap,” which measures on a scale of zero to 10 the risk associated with a product with 10 as the highest level of risk possible.

The notes have a 1.69 market riskmap while the average for the product type is 3.80.

“The market risk is low. I guess the inclusion of a pretty hefty buffer contributes to that,” she said.

The downside gearing contributes to increase the buffer amount.

“You wouldn’t be able to give a 20% hard buffer on that maturity without the downside leverage, especially on the S&P,” she said.

Geared buffers are not always popular among financial advisers, who have to explain to their clients that they may lose their entire principal.

“Investors sometimes get scared about the gearing. It’s too bad because you’re always going to do better than a barrier. If the index is down 30%, you would only lose 12.5% instead of 10% if you had a regular buffer. Maybe the banks should just do one-to-one because the gearing is off-putting. But it’s still a very good way to outperform the benchmark, and it’s such a better proposition than a barrier.”

The credit riskmap is 0.52 versus an average of 0.55 for the product type.

“The difference is not significant. It’s probably an average maturity. The creditworthiness is also probably average.”

Return score

The return score measures on a scale of zero to 10 the risk-adjusted return of a given product.

The score is calculated based on the best among the five return scenarios, which are neutral assumption, bull and bear markets, and high- and low-volatility environments.

For this particular product, the best scenario is bullish.

The return score is 7.57 versus an average of 7.46 for the leveraged return category and 6.88 for all products.

“It’s pretty average for this product type, and that’s not surprising. A leveraged capped note tied to the S&P is quite straightforward.

“If your strategy is to outperform the index, if you’re relatively bullish, there is nothing in that score that should put you off.”

It may seem counterintuitive to see a return score that is only “average” when the riskmap of the product is so much lower than average.

“The risk is contained, this is true, but your return is also limited by the gearing. You don’t have a great probability to hit the cap. You still have the possibility of a high return, but there is a full range of different outcomes in between that may meet the needs of a wide range of bullish investors.”

Price score

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10.

The notes have a 9.01 price score versus an average of 7.54 for the product type.

Normally a short maturity doesn’t help the price score because the fees, calculated per annum, are not spread out over a long period of time.

“This note shows that you can still have a high value score without a long maturity. The deal was well priced and offers good value to investors. The downside gearing is one of the ways you can improve the terms,” she said.

The nature of the underlying was also a factor.

“The pricing is pretty competitive for leveraged notes on the S&P. There are hundreds of them. Both the competitive environment and the liquidity of the underlying make for a good value proposition,” she added.

“A more complex product or a less transparent underlying makes it more expensive for the bank to hedge.

“Sometimes we see complex products that price well. But in general, simplicity goes hand in hand with good pricing.”

Overall score

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. The score is the average of the price score and the return score.

The notes have an 8.29 overall score, compared with an average score of 7.50 for the leveraged return category and 6.70 for all products.

“This is well above the average. This product is very common and fits well among its peers. It offers a generous buffer, and the cap doesn’t penalize returns very much. If you’re bullish, this is a well-balanced product.”

Goldman Sachs & Co. is the agent.

The notes are guaranteed by Goldman Sachs Group, Inc.

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