UBS’ $2.3 million autocalls show daily knock-in, dispersion, higher call strike to boost yield

By Emma Trincal

New York, June 7 – UBS AG, London Branch with an issue of $2.3 million of notes tied to two indexes and one ETF was able to price an eye-popping coupon but not without adding a substantial level of risk, sources said.

The trigger autocallable contingent yield notes with daily close monitoring knock-in due Sept. 6, 2024 linked to the worst performing of the Nasdaq-100 index, the Russell 2000 index and the VanEck Vectors Gold Miners ETF pay a contingent monthly coupon at an annual rate of 18.5% if each underlier’s closing level is at least 65% of its initial level on the corresponding observation date.

The notes will be automatically called at par plus the coupon if each underlier closes at or above its 110% call level on any monthly valuation date after six months.

If the notes have not been called, the payout at maturity will be par unless any underlier closes below its 65% knock-in level during the life of the notes and any underlier finishes below its initial level, in which case investors will lose 1% for every 1% that the worst performer finishes below its initial level.

Call

“I hate to say that a note is good or bad. Some people really want yields close to 20%,” said a market participant.

The structure suggested that investors were willing to take more risk in order to collect more income and over a longer period of time.

“The only way you can make money is with the coupon. So, the longer you hold the notes the more you collect. By the same token, the odds of breaching the barrier at maturity are greater,” he said.

The six-month no-call gave investors a longer opportunity to receive the coupon, he said.

In addition, the 110% call threshold lowered the probabilities of an automatic call.

“You can get the coupon for six months if the market is above 65% and it may not be easy to get called. It’s a good thing if you want to collect your coupon longer. But again, you’re raising the odds of hitting the barrier, especially if it’s monitored each day,” he said.

Correlations

An additional risk factor was the choice of the underlying assets. Investors in the worst-of are subject to the market risk of each underlier. A negative or low correlation between the underliers raises the risk of market losses, he noted.

“Gold miners, small caps and tech are probably not correlated. This is how the issuer can price this huge coupon,” he said.

The coefficient of correlation between the Van Eck Vectors Gold Miners ETF and the Nasdaq-100 is 0.20 with 1 being the perfect correlation. Separately, the Van Eck ETF and the Russell 2000 index show a coefficient of correlation of only 0.16.

Daily knock-in

Perhaps the most striking risk factor was the use of a daily close monitoring knock-in for the repayment of principal at maturity.

“It brings higher risk. But that’s how issuers and brokers meet the requests of their clients. If you want an 18.5% coupon with a low barrier and a short tenor, obviously, you’re going to have to take more risk. If clients and their advisers make those demands, the issuer has to make it work.

“This is an aggressive income note, a very tactical retail play,” he said.

Too short

Mark Dueholm, chief fixed-income trader at Landolt Securities, said he was not comfortable with the structure.

“You have pretty risky correlations with gold in it. Also, gold can be very volatile. All three can be volatile, but gold especially so,” he said.

The 15-month maturity was another concern.

“The shorter these are, the riskier,” he said.

“I like to make those notes longer to mitigate risk. If we have a big crash, the market is going to come back. It’s just a matter of time. If you have the time, you’ll move out of the crash.”

The 65% barrier size was not enough for this trader.

“We want 60% at least.”

American barrier

American barriers are rarely used for principal repayment, he noted.

A so-called American barrier is one observed during the life of a note, in this case, on each trading day.

“I don’t like those American barriers. They’re much riskier,” he said.

“Sometimes they’re used for the coupon. But as a measure of how much money you can lose at maturity, they’re not attractive at all.”

Finally, the call trigger set at 110% instead of 100% was another drawback.

“It’s totally unusual to have this call price higher. In many deals, it’s just the opposite. You get called if the index is above 80%. Of course, the coupon is not going to be the same. But with this step-up, you’re taking a lot more risk,” he said.

Investors buying the notes would have to be confident that none of the three underliers will drop more than 35% at any time during the life of the notes.

“That’s a stretch, and for this reason, I wouldn’t use it,” he said.

“This note is packed with risky features. There is more risk for things to go wrong.

“It pays a high coupon for sure. But for the risk I’m taking, the coupon is not high enough for me.”

UBS Financial Services Inc. and UBS Investment Bank are the agents.

The notes settled on Monday.

The Cusip number is 90279GLR8.

The fee is 0.25%.

© 2015 Prospect News.
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