Wells Fargo’s market-linked notes tied to Russell 2000 index aimed at mildly bullish investors

By Emma Trincal

New York, June 28 – Wells Fargo & Co.’s market-linked securities – with contingent fixed return and contingent downside – due July 5, 2022 linked to the Russell 2000 index, target a wide range of investors at the exclusion of real bulls, sources said.

Despite its name, the product is a barrier digital note which limits the fixed return on the upside regardless of the index appreciation.

The payout at maturity will be par plus the contingent fixed return, which is expected to be 36% to 40% and will be set at pricing, if the index finishes at or above its initial level, according to a 424B2 filing with the Securities and Exchange Commission.

If the index falls but finishes above the threshold level, 60% of the initial level, the payout will be par. Otherwise, investors will lose 1% for each 1% decline from the initial level.

“This looks fairly attractive to me. If the index is up 1/10th of a percent, I get 40%. Obviously you can’t be too bullish. If it does poorly, I just get my money back unless it turns out to be really, really bad, in which case I’m long the index,” a source said.

A more than 40% decline in the Russell 2000 index five years from now was a “very unlikely” scenario, he said.

“It would have to be worse than during the financial crisis. And it’s a five-year term.”

The U.S. small-cap benchmark dropped 33.65% in 2008.

For this source, the longer the term, the less likely such a negative outcome may occur because stocks have enough time to recoup their losses over time.

“From a less-risk perspective, I’d rather have a long maturity note with these parameters at this point in time,” he said.

“A longer maturity increases the exposure to credit risk. But in this case, the creditworthiness of the issuer offset the time effect. Certainly Wells Fargo is very high on the credit rating scale.”

Wells Fargo has the tightest credit default swap rates among big U.S. banks, according to Markit.

This issuer’s five-year CDS rates are at 42 basis points versus 63 bps for Morgan Stanley and 67 bps for Goldman Sachs. Bank of America and Citigroup have rates of 50 and 52 bps respectively. JPMorgan showed the second-tightest spreads after Wells Fargo at 47 bps.

“If your outlook is flat to negative, the worst thing that can happen is you get your money back,” he said.

“If you’re bearish to a point where you think the market is going to be down 40%, you should buy canned food rather than structured products.

“Optically, this looks like a pretty good deal.

A buysider disagreed.

“We don’t like to do these things for more than a year. Locking up your money especially for that long while limiting your upside doesn’t really make sense to us,” this buysider said.

On the downside the barrier, despite its size, was also a negative in his view.

“The idea of being protected up to a certain point but if you breach...no more protection...you just lose a big chunk of your capital, we don’t see that as very valuable. The index is down 41% and you take a 41% loss. This is not protection,” he said.

The notes, he continued, are probably “sold, not bought.

“I mean nobody is going to look at the prospectus and say: I want to buy that. If they do they don’t really know what they’re doing. The market could be up more than 36%. It could be down more than 40%. You have no way to know. And your money is tied up.”

As an alternative, this buysider said that his firm buys notes on the secondary market to get better terms and shorter life before maturity.

“The secondary is a bid-ask system. It’s supply and demand. Many people sell for many different reasons. It could be for a vacation or for college education. You need money for a number of reasons. All of a sudden rates go up. I can get better [terms] on a risk-free asset. I want out,” he said.

When supply is greater than demand, his firm can get deals priced at a discount.

“We’re not necessarily buyers. It depends on the product. The note has to offer good value. We’re not just going to buy anything simply because it’s at a discount,” he said.

A long tenor such as the deal’s five-year term is a source of “anxiety” for this buysider.

“There’s so much more that can happen in five years,” he said.

“With the digital return your upside is already known.

“But there is more time for the market to go down. Your downside time period is extended; it creates more opportunities to lose money.”

Wells Fargo Securities LLC is the agent.

The notes (Cusip: 94986R6N6) will price on Friday and settle July 5.

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