Scotia’s market-linked step-up autocalls on financial basket to beat modest performance

By Emma Trincal

New York, March 16 – Bank of Nova Scotia’s 0% autocallable market-linked step-up notes due April 2024, linked to a basket of three financial stocks give investors who are mildly bullish on the sector an opportunity to outperform a long position in the three components, sources said.

The basket consists of the common stocks of Citigroup Inc., JPMorgan Chase & Co. and Morgan Stanley, each with a weight of 33.33%, according to an FWP filing with the Securities and Exchange Commission.

The notes will be called at par of $10 plus an annualized call premium of 14% to 15% if the basket closes at or above the initial level on any annual observation date. The exact call premium will be determined at pricing.

If the basket finishes above the step-up level – 145% of the initial level – the payout at maturity will be par of $10 plus the basket gain.

If the index is unchanged or gains by up to the step-up level, the payout will be par plus the step-up payment of 45%.

Investors will lose 1% for each 1% decline.

Beating the stocks

“It’s a good thing to have a basket and not a worst-of. You have the same downside as if you invested in the basket directly,” an industry source said.

“If you average out the dividends, you’re giving up approximately 2% for the basket. That’s 6% roughly for the three years, which will finance your premium.

“It’s a way of outperforming if the market doesn’t go up fast.

“A 14% premium is pretty good especially if the basket doesn’t move up much or stays flat. You can really outperform a long position in the three stocks.

“Getting the full upside if you’re not called is also a great benefit. If the basket is up 100% you get that 100%. Your only opportunity cost is roughly the 6% of unpaid dividends. Of course, it’s not under this scenario that the note will offer its best value. Its best value is when the market is slightly up.”

Unlimited upside

If the notes do not get called, the particularity of those market-linked step ups – also called “jump securities” with other issuers – is that investors will be able to fully participate in the upside.

Such benefit is an answer to bulls that are reluctant to see a coupon or a premium cap their potential gains.

But a market participant questioned the real value of this feature.

“People are not buying this note for the uncapped return at maturity or if they do, that’s the wrong reason or perhaps it’s been sold to them that way in which case it’s gimmicky,” he said.

Call first

“You buy this for the possibility of being called at a higher price. That’s if you’re moderately bullish. You don’t anticipate the sector going up too much.

“If that’s the outlook, you’re willing to take the downside risk to outperform.

“If you’re not called after the first and second year, the possibility of being above the 45% call premium at maturity is so low, it’s kind of cheap to price the no-cap.

“You would have been down two years in a row and all of a sudden, after three years, the basket is up 45%. Very unlikely.”

Rather than seeking unlimited upside participation at maturity, investors would be better off focusing on the calls.

“Personally, I’d rather have a higher premium or maybe a step down for the call. You get called at a lower threshold, which increases your chances of getting paid even if you may get a little bit less premium,” he said.

BofA Securities Inc. is the agent.

The notes will price in March and settle in April.

© 2015 Prospect News.
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