Toronto-Dominion Bank’s five-year accelerator notes linked to S&P 500 offer no cap, 20% buffer

By Emma Trincal

New York, Sept. 20 – Toronto-Dominion Bank plans to price 0% buffered accelerator notes due Oct. 5, 2021 linked to the S&P 500 index, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par plus at least 114% of any index gain. Investors will receive par if the index falls by up to the 20% buffer and will lose 1% for each 1% decline beyond the buffer.

“If this 20% had been a barrier, I would have said it’s not enough. But with a 20% hard buffer, this note is actually attractive,” said Jerry Verseput, president of Veripax Financial Management.

Hard protection

Verseput said that one could get 50% protection over a five-year term with 1.5 times leverage and no cap.

But it would be a completely different deal.

“We did buy those terms a year ago, but the 50% on the downside was a barrier, and the structure was a worst-of tied to the Russell 2000 and the S&P 500,” he said.

“This is a great example of just how many variables there are. You can get more leverage and a deep protection, but it’s going to be a barrier, not a hard buffer.

“So I think this one is pretty good.”

The notes offer a good alternative to a direct exposure to the S&P 500.

“If you want to own the S&P, you get a 20% buffer. You’re pretty much guaranteed to beat the market on the downside.

“The 114% participation is actually not bad. It offsets the dividends a little bit.

“You’re getting a pretty good range of beating the market.

“There is just a little window of return where it would have paid off to get the dividends.”

Bullish

A flat market, however, may not produce a favorable outcome for investors in the notes, he said.

“We just customized a note for that scenario, and we ended up with a digital,” he said.

As the leverage factor is limited, the break-even point where investors do better with the notes than with the equity may need to be higher, he explained.

“There is a level where you come out ahead with this note. But a flat market is not going to work to your advantage. In a flat market, just buying the S&P would make more sense.”

No cap

The notes offer another appeal: the uncapped return.

For Verseput though, this feature is part of his routine when picking or tailoring structured notes.

“I just don’t look at them if they have a cap. I won’t see as many, but I have no problem limiting my choices,” he said.

Credit

The five-year term raises the issue of credit risk.

“I guess the only question is to take a look at TD Bank. You’re taking five years’ credit risk. It’s always important to look at it for any note but particularly right now where you see some foreign banks going through tough times,” he said.

Toronto-Dominion Bank has an AA- rating from S&P.

Dividends

Steven Foldes, vice-chairman of Evensky & Katz/Foldes Financial Wealth Management, saw a few problems with the notes, primarily its five-year duration and leverage factor.

“The issuer has quite a good rating, but going out five years is always problematic for us,” he said.

The leverage is “fine” but insufficient, he added, given the fact that investors only get the price return of the index instead of its total return.

The S&P 500 yields 2%. Over a five-year term, investors give up 12.6% on a compounded basis, he added.

“That’s a substantial amount. Not getting 12.6% over the five years almost appears to be a wash between what you get at maturity with the leverage and what you would be getting with the dividends.”

Buffer and term

The buffer, which is the main appeal of the structure, does not offset the negatives, which are the non-payment of dividends over a long period of time and the modest leverage, he noted.

“Buffers are very nice, but they lose their effectiveness the longer you hold the notes,” he said.

“They’re happy to give you buffers over longer periods because that protection is really inexpensive. The likelihood that you would get a 20% decline after five years is very modest. It doesn’t happen very frequently; that’s why the cost of this protection is low.”

Naturally, the same buffer on a shorter note would be very costly.

“But it would be more meaningful,” he said.

Increase the leverage

Foldes said that he would not consider the notes as they were offered.

“Right now you give up a significant amount of dividend, your leverage on the upside is very modest, and your buffer while nice is not that meaningful,” he said.

He noted, however, that the notes are “unusual” in that there is no cap.

“Usually leveraged buffered products are capped, but I think it’s simply because the leverage is so small,” he said.

In order to improve the notes on the same five-year tenor, Foldes would choose more leverage to make up for the loss of dividends. In exchange, he would be willing to have “a lower or even no buffer.”

But such reinvention of the notes over the same period of time would be moot.

“The non-starter for us is the five-year [term].”

TD Securities (USA) LLC is the agent.

The notes will price Sept. 30 and settle Oct. 5.

The Cusip number is 89114QXP8.

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