RBC's $155.5 million Accelerated Return Notes tied to S&P 500 top equity index deal of year

By Emma Trincal

New York, Aug. 2 - Royal Bank of Canada priced the largest equity index offering so far this year with $155.5 million of 0% Accelerated Return Notes due Sept. 28, 2012 linked to the S&P 500 index, according to data compiled by Prospect News.

Sources said that the popularity of the deal is the result of its simplicity and digital-like payout structure.

The payout at maturity will be par of $10 plus triple any gain in the index, up to a maximum return of 14.55%. Investors will be fully exposed to any index decline, according to a 424B2 filing with the Securities and Exchange Commission.

Simple

"The simpler, the better," a market participant said.

"People are shying away from knock-in and knock-out or other exotic notes. They just want a simpler payoff.

"Part of it is because of the concerns regulators have about structures that won't likely pay out."

Digital-like

A New York-based structurer said that the payout is very similar to a digital note, which makes the structure more attractive, especially for mildly bullish investors.

"This is an enhanced delta one for a flat to moderately bullish outlook," he said.

By delta one, he meant that investors on the downside have the same risk exposure they would have if they directly invested in the index.

Investors anticipate only a moderate increase of the S&P 500 index over the next 12 months, according to the prospectus.

For instance, if the index is up 3%, the return will be 9%. But over a 5% benchmark performance, investors will not earn more than the 14.55% cap for the one-year term.

"You have more leverage than usual. You don't see three-times leverage that often anymore," the structurer said.

"I think this explains in part the popularity of the deal."

The amount of leverage does not only shape the size of the potential return up to a point but also the payout structure, he explained.

"The higher the gearing, the closer it is to a digital," he said.

"With a 1.5 times leverage for instance, you really need to see the index rise to benefit.

"But here, it only takes a 5% increase to hit the cap. So if the index is up, it's very likely that you're going to max out the return.

"It's going to be either a negative return or the maximum return.

"As soon as you reach 5%, you're going to make 15%. That's a very big boost. That's why people liked it."

The structurer compared the structure to a variety of "very popular" market-linked certificates of deposit linked to a basket of stocks that use a payout calculation feature called "auto-cap."

With these, each stock performance is accounted for as either an auto-cap or a negative return. If a stock's return is zero or positive, its performance is equal to the auto-cap. Otherwise, its performance will be equal to its negative return.

"As soon as the stock return is above the initial level, its performance is recorded as the cap.

"In this case, it's not exactly the same since you need to go up to 5% to reach the cap, but you have similarities," the structurer noted.

Merrill Lynch

The offering, which priced Thursday, was sold by Bank of America Merrill Lynch.

"It probably didn't hurt that Merrill Lynch was the agent for the deal," the structurer added.

Merrill Lynch was also the agent for this year's top equity-linked product, which was sold in March. Linked to a single stock, it was AB Svensk Exportkredit's $185.75 million of 9.75% STEP Income Securities due March 23, 2012 linked to Ford Motor Co.

Risk/return

But some said that the structure issued last week is not that attractive to them because it offers too much downside risk for a limited upside.

"This would not be the kind of structure we would be interested in," the market participant said.

"With a cap that low over one year, you're not going to get that much equity return. And you're taking an awful lot of equity risk without the buffer.

"I'm surprised they did that much."

Fees were 2%.

The Cusip number is 78009M777.

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