BNP introduces new equity research-based note with first use of S&P Capital IQ Stars stocks

By Emma Trincal

New York, Oct. 9 - Tapping into investors' growing interest for research-based notes, BNP Paribas is planning to price a stock basket-linked note that uses an equity research provider not found in other structured notes so far.

The French bank has licensed the use of S&P Capital IQ U.S. STARS in connection with the notes, which will be tied to a basket of 10 stocks that received a five-star ranking by S&P Capital IQ's Stock Appreciation Ranking System.

"This is the first time we are offering a note linked to a basket of stocks using the research process of S&P Capital IQ's," Serge Troyanovksy, managing director and head of retail distribution North America for structured products, told Prospect News.

"To my knowledge, it's the first time the research of this particular equity ranking provider is being used in the design of a structured note by any issuer.

"There is a thematic inspiration for the basket. It is composed of the strong buy recommendations from this equity research provider," he stated.

S&P Capital IQ's Stock Appreciation Ranking System gives a stock a five-star ranking if its total return is expected to outperform the total return of a relevant benchmark by a wide margin over the next 12 months, with its shares rising in price on an absolute basis, according to the term sheet.

Equity research

Whether used in notes or certificates of deposit formats, baskets or indexes that reflect "best picks" from a well-known equity research provider are not new. But they have grown in favor of late.

HSBC Bank USA, NA, for instance, issues CDs tied to a basket of stocks that have received a Morningstar Economic Moat rating of "Wide."

"HSBC has been doing these CDs for a while, basically every month," said Troyanovksy.

BNP's subsidiary Bank of the West is also involved in the sale of CDs tied to the Morningstar Ultimate Stock-Pickers index.

With notes, Bank of Montreal back in January priced $75.26 million of notes linked to Raymond James Analysts' Best Picks for 2012 and distributed by the Canadian Bank's affiliate BMO Capital Markets.

But S&P Capital IQ so far appeared to be missing from the list.

New kid in the block

"The innovation here: It's a different research provider. It's S&P. S&P is widely known for its credit ratings," said Troyanovksy.

S&P Capital IQ is also known among investment banks, asset managers, research firms, private equity firms and hedge funds as a multi-asset class research and analytics provider.

According to the term sheet, Standard & Poor's Financial Services LLC has published recommendations on common stocks since the 1920s.

In 1986, S&P Capital IQ introduced the STockAppreciation Ranking System (STARS) in the United States. In 2002, it began producing recommendations on European and Asian stocks as well. STARS emphasizes bottom-up fundamental research, but also employs top-down analysis by S&P Capital IQ's equity research team.

BNP remains involved in the stock selection process since it has to pick 10 stocks out of the 5-STARS list.

"We utilize our standardized approach for selecting the stocks. We choose broadly diversified, well-balanced basket with the best economics that we can put together," said Troyanovksy.

"If you are able to put together a broadly diversified basket with a higher auto-cap, it gives clients a potentially better chance to perform well."

Autocap CDs

Besides incorporating a "best-pick" component, the new note is also the result of a demand for principal-protected notes tied to baskets.

The bulk of this market is currently in CD format, Troyanovksy said.

"We issue four Market Linked CDs offerings tied to baskets of stocks every month. Some of the leading issuers may do more. You have in this market HSBC, JP Morgan, Barclays and others," he said.

One of the common structural features of these CDs also adopted by the upcoming notes is the so-called auto-cap.

"It is by far the most dominant structure. It is very popular in the CD market because it's the only one out there that allows you to have an annual income very similar to the standard CD.

"It offers value to the investor because the stock doesn't have to go up that much to hit the autocap.

"It's sort of new for us to issue an autocap wrapped in a note format. We've only started doing this in the past three months," Troyanovksy noted.

According to the term sheet, interest is payable annually in an amount equal to the average of the stocks' performances, subject to a floor of zero.

If a stock's return is positive or flat, its performance will be equal to the auto cap. If a stock's return is negative, its performance will be the greater of the stock return and the return floor. The auto cap is expected to be 6% to 8%, and the return floor is expected to be negative 20%. Both will be set at pricing.

The payout at maturity will be par plus the final coupon, if any.

Expanding market

"With the launch of this note, BNP wants to tap into a new trend: the growing demand, especially from CD buyers or conservative investors for a similar structure and underlying but with better terms. That's when you have to look at using a note wrapper," said Troyanovksy.

"Issuers are launching annual coupon structures tied to baskets in note format. The structure has proven itself very popular in the market-linked CDs space. Now, it's emerging as a viable alternative to CDs.

"We think many market-linked CD clients looking for higher caps and seeking a conservative exposure to stocks may be willing to explore buying similar products in a note format.

"It's a different marketing approach however. These CD investors now have to agree to be exposed to credit risk. They also have to be willing to give up the death put," he added.

The death put is an estate feature included CD terms that allows the beneficiary of the estate of a deceased investor to put the CD back to the issuer.

"But potentially they can get better economic terms and some may see the appeal of switching to notes," the source noted.

"Because those autocap have been so popular in CD format, we see more and more brokers who are familiar with the structure and looking for higher cap levels for their clients beginning consider these notes as a supplement of distribution for market-linked CDs.

"It's going to take some time for the client that has been used to this structure within a CD to adopt it as a note. But I think eventually, it's going to happen and we've seeing the emergence of a new trend," Troyanovksy added.

In order to make the product more compelling, issuers may have to incorporate additional benefits.

"We think the research-based component could add significant value. You have to structure your note in a way that becomes more compelling, that provides an additional level of comfort for the client," he said.

S&P Capital IQ's equity research analysts have been included in The Wall Street Journal's "Best on the Street" equity research surveys since 2002, according to a marketing document from S&P Capital IQ.

"They've been rated No. 2 in the U.S. as an independent provider after Morningstar," said Alexandre Peroux, vice-president in BNP's global structuring group.

Talking about baskets of stocks selected by equity research analysts, he said: "There is a need because clients want to know where the stock is coming from: the story, the reasons, the rationale behind the selection of 10 stocks in a basket. By using the picks of S&P Capital IQ's top analysts, that's exactly what we are trying to do."

The notes are expected to price on Oct. 26 and settle on Oct. 31.

The Cusip is 05574LAM0.

The underlying stocks are Aflac, Inc., Applied Materials, Inc., CME Group Inc., Fastenal Co., Huntington Bancshares Inc., McDonald's Corp., Philip Morris International, Inc., Tiffany & Co., Valero Energy Corp. and Windstream Corp., equally weighted.

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