RBC’s 37-month buffered bullish return notes tied to S&P 500 are ‘well priced,’ analyst says

By Emma Trincal

New York, Nov. 6 – Royal Bank of Canada’s 0% buffered bullish enhanced return notes linked to the S&P 500 index offer attractive terms and accordingly better-than-average scores, said Tim Vile, structured product analyst at Future Value Consultants, a research firm that rates structured notes based on their risk, return and value.

The notes will mature 37 to 40 months after the issue date, according to an FWP filing with the Securities and Exchange Commission.

Structure

The payout at maturity will be par plus 145% of any index gain, up to a maximum return of 42.05%.

Investors will receive par if the index falls by up to 15% and will lose 1.1765% for every 1% decline beyond 15%.

“This note offers a pretty good upside potential,” said Vile.

“The 42% cap is the equivalent of a 12% annualized return on a compounded basis, which isn’t bad. The S&P needs to rise by about 9% a year. It’s reasonable.

“If there is a market pullback followed by slower growth, having the leverage may be handy. And 1.45 offers some good leverage.

The 15% buffer was “quite unusual” for a three-year note, he said, especially with the S&P 500 index as the underlier.

In order to run his model, Vile picked the lower end of the duration announced in the prospectus, or 37-months, the equivalent of approximately three years.

“The S&P is not extremely volatile. But they still give you some solid protection,” he said.

“While it’s a geared leverage, it’s still better than a barrier. It’s going to slow down the amount of capital losses.”

The notes show good scores, according to Future Value Consultants’ research report on the product.

Low risk

In terms of risk, as measured by the firm’s riskmap, the notes have a below-average score of 2.82 versus 3.84 for the average product in this category. The category is leverage return.

The riskmap measures risk on a scale of zero to 10 with 10 being the highest level of risk possible.

Future Value Consultants’ riskmap is the sum of two risk components – market risk and credit risk, which are measured on the same scale.

The notes have a market riskmap of 2.23 versus an average of 3.28 for the product type, according to the report.

“It’s very low risk and the 15% really contributes to it. Also the S&P is less volatile than other benchmarks used in those products,” he said.

On the credit risk scale, the notes are just about average at 0.59 against 0.56 for the average of similar products.

“Royal Bank of Canada has very strong credit ratings. The credit risk should have been lower but the duration may have offset the credit advantage. A majority of leveraged notes tend to be shorter than three years, which reduces the exposure to credit risk,” he said.

Risk-adjusted return

Another above average rating was the return score. This score measures on the zero-to-10 scale the risk-adjusted return of a note, with 10 the best level.

At 8.31, the return score is higher than the 7.86 average for the leveraged return category.

“It’s a very strong score, almost half-a-point above average,” he said.

“The main factor is the very low risk level.

“It is capped on the upside, but 42% over three years is still very good.”

Value

The competitive return score had a positive impact on the value of the product, as measured by Future Value Consultants’ price score.

This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value to investors.

The price score is 9.18 versus an average of 6.16 for similar products, according to the report.

“It’s very good. You have a lot of pieces in this structure, which put together, add considerable value.

“First there is this 15% buffer. The cap is also very decent. Three years is not short but it’s not considered long-term either.

“It’s surprisingly well priced.

“You almost wonder how they were able to price this product. The downside leverage must have helped a lot, possibly the dividends as well.”

Overall

Future Value Consultants gives its general opinion on the quality of a deal with its overall score. The overall score is simply the average of the price score and the return score.

The notes have an overall score of 8.75 while the average for the product type is only 7.01.

“This is a very decent product. Obviously the pricing really helps. You can see this product as an option for bullish investors given the cap level. It may also work for moderately bullish investors who rely on the leverage to get them to a higher return in a slow growth environment. Even slightly bearish investors may find the buffer attractive.

“We don’t get to see that many products that have terms quite like this one.”

RBC Capital Markets, LLC is the agent.

The notes will settle on Thursday.

The Cusip number is 78012KJK4.

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