Goldman subsidiary prices No. 3 deal of year with $350 million leveraged notes tied to S&P 500

By Emma Trincal

New York, Oct. 27 – Goldman Sachs Group, Inc. brought two surprises last week: the pricing of the third largest structured note deal of the year so far and the issuance of that deal through one of its subsidiaries, GS Finance Corp.

GS Finance’s $350 million of 0% leveraged buffered notes due Oct. 5, 2016 linked to the S&P 500 index are guaranteed by Goldman Sachs, according to a 424B2 filing with the Securities and Exchange Commission.

The upside participation in the index is 150% up to a 13.65% cap. The structure offers a 5% buffer on the downside.

So far the top deal this year is Barclays Bank plc’s $547.56 million of 0% capped return enhanced notes due Feb. 18, 2016 linked to basket of international indexes consisting of the Euro Stoxx 50 index, the FTSE 100 index and the Topix index. J.P. Morgan Securities LLC was the agent. The deal priced on Jan. 30.

The same day, Goldman Sachs brought a note linked to the same underlying basket in the amount of $497.53 million.

GS Finance

Beyond the size, market participants noted the unusual name of the issuer, and most said they were not familiar with it.

A bank analyst who covers Goldman Sachs at a large independent equity research firm said he had “never heard of GS Finance” before.

Last week was not the first time Goldman Sachs used its GS Finance subsidiary to issue a U.S. registered deal, according to data compiled by Prospect News with records going back to January 2007.

The first two, both linked to the AIG Commodity Total Return index, were 30-year notes totaling $26 million, which priced in April 2008.

This summer, GS Finance issued another pair of offerings. Unlike the prior ones, these two had very short terms and were larger in size.

The first one, which priced in July and matured on Friday, was a $63.5 million offering based on the MSCI Europe index.

The second, issued a month later, was a $75 million offering of notes due on Nov. 13. The underlier was the Topix index.

Goldman Sachs states in its latest 10-Q filing that it “fully and unconditionally guarantees the securities issued by GS Finance Corp., a wholly-owned finance subsidiary of the firm.”

Goldman Sachs re-emphasizes its role as the guarantor of the notes in the full name it has given the product, which is “GS Finance Corp. $350,000,000 Leveraged Buffered S&P 500 index-linked notes due 2016 fully and unconditionally guaranteed by The Goldman Sachs Group, Inc.,” according to the 424B2 filing.

Resolution plans

Sources were asking themselves why Goldman Sachs would resort to using a subsidiary to issue some of its structured notes.

A lawyer offered an explanation.

“They and other banks have been under scrutiny in connection with the FDIC’s resolution plan process, also known as living wills, to simplify their issuances of securities and obligations,” this lawyer said.

Instead of issuing debt at the holding company level, which in legal parlance would be the “resolution entity,” the banks instead are requested whenever possible to issue “at other levels within the corporate family.”

The Dodd-Frank Act requires that large bank holding companies and non-bank financial companies supervised by the Federal Reserve periodically submit resolution plans to the Fed and the FDIC, according to the Fed’s website. Each plan, known as a living will, “must describe the company's strategy for rapid and orderly resolution in the event of material financial distress or failure of the company,” the Fed said on its website.

“The FDIC wants the holding company’s obligations to be as simple and straightforward as possible to make it simpler for a regulator to intervene in a crisis. Every entity in the group under the holding co simply continues and is transferred to a bridge financial company,” this lawyer said.

Too small to fail

Dick Bove, bank analyst at Rafferty Capital Markets, explained that those living wills are designed by the legislature to give the regulators a sense of how the big banks would resolve a bankruptcy crisis.

“The concept of the living will is to have the holding company ready to face a bankruptcy the most efficiently. How can it be dismembered with the least cost to the people who have invested in it? That’s what those resolution plans are,” said Bove.

“If all the debt is issued at the holding company level, there would be a claim to one big entity and the holding company may not be able to repay its creditors.

“But if you split the holding company in different sub-businesses, it will give those businesses a chance to continue to exist if the whole company was to go under.”

Institutional

The structure of the deal was less exciting than its size and the issuer, sources said. One thing, though, caught their attention: the 0.05% fee, as stated in the prospectus.

“It’s a small fee. It’s probably an institutional investor, especially with that huge size. It looks like it was just one bought deal with specifics. I don’t see it as retail at all, but that’s just my guess,” a market participant said.

He did not believe that the unfamiliar credit, GS Finance, would have discouraged investors to buy the notes.

“If it’s still guaranteed by the parent company, it wouldn’t put people off,” he said.

Tom Balcom, financial adviser and founder of 1650 Wealth Management, also saw an institution behind the trade but not a registered investment adviser.

“It’s a sizable deal. It may be a large pension or a sovereign fund, someone with a very range-bound view,” he said.

As with every structured note, investors have no right to receive the dividends. The S&P 500 carries a dividend yield of about 2%, noted Balcom.

“The probability of outperforming the index is not that great. On the upside, you have the 13.65% cap and you lose the 2% in dividends. On the downside, the buffer is only 5%,” he said.

“The index would have to be up anywhere between 5% and 11% in order for the note to outperform. You have to have a narrow, range-bound view, and even if you’re correct, your outperformance will be modest.

“Also there is a timing factor: the note matures just before the presidential elections. It adds an element of uncertainty.”

The notes (Cusip: 36250E100) priced on Thursday.

Goldman Sachs & Co. is the underwriter.

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