Scotia’s $19.45 million Mitts on Euro Stoxx 50 offer risk limited to 10% of principal

By Emma Trincal

New York, March 4 – Bank of Nova Scotia’s $19.45 million Market Index Target-Term Securities due Feb. 24, 2023 linked to the Euro Stoxx 50 index were considered as relatively attractive given the amount of protection offered over a short period of time despite a difficult pricing environment, sources said.

The payout at maturity will be par plus 111.26% of any index gain, according to a 424B2 filing with the Securities and Exchange.

Otherwise, investors will have exposure to first 10% of losses with a floor of 90% of par.

The ending value is the average of the five consecutive market days ending Feb. 21, 2023.

Timing

“Because volatility is up, especially late last week, it’s too expensive to structure a deal that provides 100% of principal protection,” said Tim Mortimer, managing director at Future Value Consultants.

“But you can do 90%.”

The deal priced on Friday at the end of a week that recorded one of the steepest sell-offs in the U.S. amid concerns around the coronavirus. European markets also felt the selling pressure. The Euro Stoxx 50 index fell by 5% on the week.

“Investors would rather have full capital protection. But at least you know that you only have 10% at risk, and if that’s all you can do in this market environment you can settle for that.”

Tough environment

As stock prices stumbled last week, investors fled for safety, pushing the 10-year Treasury yield to 1.17%, a record low. This made the pricing of principal-protection all the more challenging.

“Volatility is high. Rates are low. This maturity is short. It makes it impossible to offer full capital protection. But 90% is possible,” he said.

“The issuer still has 10% to play with.

“You have the 90% discounted by the interest rate plus the credit spreads. The bank still has a little bit of money left to buy the upside.”

Matt Rosenberg, head of trading and strategic initiatives at Halo Investing, said he has not seen many principal-protected notes lately.

Phantom income

“This is an interesting note. It falls under the principal-protection category even with 90%, rather than 100% of guaranteed repayment,” he said.

One thing those notes have in common is their tax-treatment, he said, adding that it’s one of the reasons he sees so few of them.

“I can’t provide any tax guidance but typically investors in those products have to pay a phantom income tax each year even though they’re not actually collecting any interest,” he said.

“A lot of investors are turned off by that.”

In order to return the principal at maturity, principal-protected notes are built on a zero-coupon bond issued at a discount to the face value of the notes. The difference or “original issue discount” (OID) is taxable as income every year, a less favorable treatment than capital gains or losses.

Terms, Europe

Despite the tax issue, Rosenberg said the pricing was attractive.

“The fact that you’re getting an uncapped upside with a little bit of leverage is compelling,” he said.

“I’m surprised they could even price it with rates so low.”

Noteholders as with any other structured product must forgo the dividends paid by the stocks included in the index.

The high-yielding underlying benchmark helped with pricing. The Euro Stoxx 50 index yields 3.78% compared to 2% for the S&P 500 index.

But Rosenberg was not so bullish on the underlying.

“I’m not sure Europe is the best place to invest right now. Investors are much more inclined to buy U.S. indices, which they are more familiar with,” he said.

“I think there is greater uncertainty around this coronavirus in Europe than there is here. It’s just not the place I would go to buy the dip.”

BofA Securities, Inc. is the agent.

The notes priced on Feb. 27.

The fee is 2.25%.

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