Wells Fargo's autocallables tied to iShares Russell for Eksportfinans delay reinvestment risk

By Emma Trincal

New York, March 25 - An upcoming autocallable product to be sold by Wells Fargo Securities, LLC for Eksportfinans ASA offers potential early returns after one year, giving investors the chance to earn an attractive coupon while limiting the initial reinvestment risk, said structured products analyst Suzi Hampson at Future Value Consultants.

"Investors should buy these notes expecting an early redemption on the first call date, which is one year after issuance. Otherwise, they shouldn't invest in it," Hampson said.

Most autocallables have quarterly or even monthly observation dates. This product is more unusual, she said, in that investors may expect to keep their notes for at least the first year.

Eksportfinans plans to price autocallable access securities with fixed percentage buffered downside due April 1, 2013 linked to the iShares Russell 2000 index fund via Wells Fargo, according to a 424B5 filing with the Securities and Exchange Commission.

The notes will be automatically called at par plus a premium if the fund's closing share price is greater than the initial share price on any of the call dates. The premium is 7% to 9% for the first call date of April 2, 2012, 10.5% to 13.5% for the second call date of Oct. 1, 2012 and 14% to 18% for the final call date of March 22, 2013. The exact premiums will be set at pricing.

If the notes are not called and the fund's final share price is at least 90% of the initial level, the payout at maturity will be par. Investors will lose 1% for every 1% that the fund declines beyond 10%.

The first call

"The highest chance of a kick-out is always on the first observation date. That's true for any autocallable, whether the call dates happen each month, each quarter or annually. That's because if there's no call on the first observation date, the underlying is likely to have declined in price. When that's the case, it becomes harder to make up for the losses as time goes by," she said.

Assuming an annualized call premium of 8%, Hampson compared this product with one that would have monthly call dates. Since the highest probability is always on the first call, the Eksportfinans notes give investors a high likelihood of receiving an 8% return while a product with monthly call dates is more likely to yield a twelfth of that, or 0.67%.

"The annual observation date seems a lot more attractive," said Hampson.

"The choice between monthly or annual calls also depends on how much you want to actively manage your investment and what your target maturity is.

"This product allows you to have a fixed target return for at least a one-year maturity."

Reinvestment cost

Having the first observation date after one year rather than one quarter or one month offers another advantage, she said: "It limits the potential cost of reinvesting your principal."

Each time there is an early redemption with an autocallable product, investors are subject to reinvestment risk: they have to reinvest their principal at current market rates, which may or may not be as attractive as the rate captured originally, she explained.

"A lot of times, at least in the U.K., the bank will offer a similar product, timing its new issue on the autocall dates so that it offers rollover options to investors who are looking to reinvest their principal," Hampson said.

"But if you constantly roll over the same product in short periods of time, you end up paying more in commissions," she said.

"With this product, it's not going to happen for the first year."

Reduced risk

The risk associated with these notes as determined by riskmap, a Future Value Consultants rating measuring risk on a scale of zero to 10, is "relatively low" at 3.67, said Hampson.

"This is in part due to the 10% buffer, but that's not the main reason.

"Mainly, the risk is reduced because you have two early kick-out opportunities to get your principal back with a call premium.

"As far as risk goes, you're better off with these notes than with a growth product. On the other hand, if the underlying fund doubles, you won't participate in the return. You have a fixed rate," she said.

Risk-adjusted return

The return rating, Future Value Consultants' indicator of the risk-adjusted return of the notes on the same scale, is "above average," she said at 4.65.

This score reflects the high probability of generating a gain in the highest bucket. Investors have a 77% chance of earning between 5% and 10% per year, according to the probability tables of product return outcomes.

"Again, this high probability of scoring the highest return has to do with the three chances of autocalling occurring during the term," she said.

"This is a product for investors who are bit risk averse and who would rather have a fixed return than a payout based on massive growth. If you're really bullish, you would invest in the fund instead."

Value and overall

Value, a rating that represents the real value to the investor after deducting the costs the issuer charges in fees and commissions on an annualized basis, is 8.63 for these notes. "It's a pretty high score, and since you already have an above-average return rating, it gives you a good overall score," she said.

The overall rating, on a scale of zero to 10, is Future Value Consultants' opinion on the quality of a deal, taking into account costs, structure and risk-return profile. It's an average of three scores weighted 40% to the value score, 40% to the return score and 20% to the simplicity score.

The product received an overall rating of 6.91.

The notes are expected to price in March and settle in April.

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