Five banks price nearly identical $5 million new issues with full protection, short duration

By Emma Trincal

New York, July 8 – Five different agents placed deals with nearly identical terms last week: $5 million size, short tenor, single equity benchmark underlying, quarterly averaging, full principal protection and less than 100% upside participation.

Each issuer was also the agent for its deal, according to separate 424B2 filings with the Securities and Exchange Commission.

“This is something a little unusual, and I wouldn’t be surprised if they did it at the request of one client,” a sellsider said.

The deals priced on July 2. The maturity date is the same for all issues, Sept. 30, 2016, giving them a duration of about 27 months.

The issuers are Bank of Montreal, Barclays Bank plc, Citigroup Inc., Deutsche Bank AG, London Branch and Royal Bank of Canada.

The deals priced by Barclays, Bank of Montreal and Citigroup are linked to the S&P 500 index. The deals priced by RBC and Deutsche Bank offer exposure to the Euro Stoxx 50 index.

Five deals

Bank of Montreal priced $5 million of 0% averaging notes due Sept. 30, 2016 linked to the S&P 500 index, according to a 424B2 filing with the SEC.

The final index level will be the average of the index’s closing levels on the quarterly averaging dates over the term of the notes.

The payout at maturity will be par plus 23% of the index return, subject to a minimum payout of par.

BMO Capital Markets Corp. is the agent.

The 23% participation rate is the lowest of the five deals.

On the other end, Deutsche Bank’s notes linked to the Euro Stoxx 50 have the highest rate at 37%.

Deutsche Bank Securities Inc. is the underwriter.

In the middle of the range, Citigroup’s issue linked to the S&P 500 has a 31% participation rate, Barclays’ deal linked to the S&P 500 has a 27% participation rate, and RBC’s notes linked to the Euro Stoxx 50 also have a 27% upside rate.

Reverse inquiry

“Looks like a one-off deal,” the sellsider said.

“It could very well be a pension fund who did the transaction but wanted to spread the risk across different banks. It makes sense. If it’s a pension fund, they have a target. They want to generate a certain return per annum, but they can’t really lose principal. They’re limiting the percentage participation. Worst case, they don’t earn anything at the end of the two years. It’s not great, but it’s a two-year, not a six- or seven-year. With interest rates as low as they are today, it’s certainly an easier sale.”

The five structures offer quarterly averaging pricing. The final index level will be the average of the index’s closing levels on the quarterly averaging dates over the term of the notes.

“You’re getting less than the index because your participation rate is less than 100%. On top of that, the quarterly averaging eats up your return as well,” the sellsider said.

“The averaging makes the call option cheaper for the issuer. That’s why they’re using it instead of a point to point.

“Why would an investor do this? Well, that’s probably the only way to structure a principal protection on a two-year term with one single underlying index.

“The client probably wanted a two-year term on one index with the protection, so they had to play with the participation rate. That’s the only variable left, and that’s what they had to do.”

Bond bucket

Tom Balcom, founder of 1650 Wealth Management, was not convinced about the benefits of the notes for an equity investor despite the short tenor and downside protection.

“It’s probably for someone who believes the market is at all-time highs and that there isn’t much more to capture from the market,” he said.

“If we’re up 10% over the next two years and you’re taking only 23% of this, that’s 2.3%. You can find a bond fund yielding 2.3% or 4% for the next two and a half years, so I’m not entirely convinced it would make sense as a bond replacement. The only reason it could be used as a bond substitute would be to address interest rate risk. Unlike a bond fund, which would lose value if interest rates went up, this equity-based note would be a better investment should the Fed decide to raise rates.”

Nearly bearish

Balcom said that in general, most notes serve a purpose for one particular category of investor. He was not sure, however, who would be the most suitable client for these products.

“It would certainly not be an equity replacement. You would really have to be convinced that we’re heading for some sort of correction. This is a note for people who worry a lot about the Dow Jones hitting 17,000,” he said.

“If you compare this with a capped note, it’s probably not an easy sale. The underlying view of this note is actually almost bearish.

“Imagine the market is up 20% and you have a 13% cap. You have to explain to your clients that you’ve underperformed, but they accept that because of the protection.

“Now imagine you use this note with a 23% participation rate. You’re getting about 4.5% in return over the two years. This time, investors are not going to be so happy. It’s a very high price to pay for the protection.

“Only a slightly bearish adviser would be willing to risk having this kind of conversation with a client. You have to explain that giving up three-quarters of the returns makes sense if you want to protect your principal. That’s a tough sale.

“I could see this note as a bond substitute if you worry about rates going up. I guess you could make a case for that.

“But as an equity replacement, unless you’re a bear, it doesn’t make a lot of sense.”

Citigroup Global Markets Inc. was the underwriter for the Citigroup offering. Barclays and RBC Capital Markets, LLC were the agents for the Barclays Bank and RBC issues, respectively.

The fee per deal was 0.25% except for the Bank of Montreal offering, which carried a 0.20% fee.

The Cusip numbers for the notes were as follows: 06366RVF9 for Bank of Montreal, 06741UFL3 for Barclays, 1730T0U64 for Citigroup, 25152RLX9 for Deutsche Bank and 78010UK48 for RBC.

© 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.