RBC’s $49.47 million leveraged notes seen as risky due to short tenor, downside payout

By Emma Trincal

New York, Aug. 30 – Royal Bank of Canada was able to price short-dated notes with no cap and leverage on the upside. But as a tradeoff, investors had to give up the downside protection, which for some market participants was viewed as too risky.

RBC priced $49.47 million of 0% leveraged notes due Oct. 2, 2024 linked to a basket of indexes, according to a 424B2 filing with the Securities and Exchange Commission.

The basket consists of the Euro Stoxx 50 index with a 36% weight, the Topix index with a 26% weight, the FTSE 100 index with a 17% weight, the Swiss Market index with an 12% weight and the S&P/ASX 200 index with an 9% weight.

The payout at maturity will be par plus 176.2% of the basket gain.

Investors will be fully exposed to any basket decline.

Multi country bet

Mark Dueholm, chief fixed-income trader at Landolt Securities, said taking a view on the basket may not be easy.

“I find it a little bit complicated for retail investors since you have all these different weightings and foreign indices. It’s hard to explain why the weightings are so different. You probably have to have a specific view on international equity markets,” he said.

“Generally, our clients prefer U.S. equities.”

High risk

The 100% downside exposure put investors at a disadvantage, he noted.

“It’s very high risk, not only because you have total downside exposure at maturity but also because it’s such a short-term play,” he said.

“The market can blow up in 13 months and you have no time to recover. On a longer tenor, chances are the market will come back.

“This is not something I would want to use for my clients.”

Unconventional

Dasale Arachi, head of U.K. distribution at Hilbert Investment Solutions, said he was surprised not to see any form of a safety net.

“Structured products typically offer some kind of downside protection. That’s one of the main reasons people buy them; otherwise, why not be long the underlying? So, it’s a bit odd not to have any barrier or buffer on the downside,” he said.

Arachi conceded that from a pricing standpoint, a short-duration note with uncapped leveraged upside and a single underlier (as opposed to a worst-of) may be challenging to price.

“I understand why it was constructed this way. But to me, a better tradeoff would be to put a cap and to get a higher participation for this short-term note,” he said.

“More leverage is always good especially for this type of underlying. You may not see a huge amount of growth in some of those indices like the FTSE and the Euro Stoxx.”

Return enhancement

This note could be compared to other short-term leveraged notes, in which issuers have also removed the downside protection.

A very common product, often sold under the BofA Securities platform, consists of unprotected leveraged notes, in which investors agree to a cap for a much higher amount of leverage.

Last week for instance, HSBC USA Inc. priced $20.64 million of 14-month Accelerated Return Notes linked to a weighted index basket of international equity indexes (Cusip: 44328M294.) The basket was slightly different, but the structure similar in that investors were exposed to the downside on a short maturity. The difference was the upside payout: triple any basket gain, up to a cap of 20.85%.

Without commenting on this second offering, which he did not look at, Arachi said that very often, having more leverage even with a cap makes sense when one does not expect a lot of growth.

“Three times leverage is much better. I would still want the downside protection for retail clients. But if you have to go without it, I’d rather see a cap with higher participation. A 176% participation rate is not that high compared to 300%.

The key with caps was to find the right level.

“Once you are OK with this tradeoff, it’s a matter of finding the maximum return that you’re comfortable with, one that’s really achievable,” he said.

RBC Capital Markets, LLC is the agent.

The notes settled on Monday.

The Cusip number is 78016NUQ8.

The fee is 0.94%.

© 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.