Scotia’s $50.94 million buffer autocalls on S&P 500 offer deep buffer, modest call premium

By Emma Trincal

New York, May 18 – Bank of Nova Scotia’s $50.94 million of 0% buffer autocallable gears due May 17, 2028 linked to the S&P 500 index provide a large buffer over a five-year period but the call premium after one year is lower than comparable but shorter structures.

If the index finishes at or above its initial level on May 1, 2024, the notes will be automatically called at par of $10 plus 8%, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called and the index finishes above its initial level, the payout at maturity will be par plus 1.7091 times the index gain.

Investors will receive par if the index declines by 20% or less and will lose 1% for every 1% that the index declines beyond 20%.

Steve Doucette, financial adviser at Proctor Financial, said he has seen the structure before and does not like it.

“Whether the note is a short- or long-term note, once you get a call after one year, you’re capped. Whatever you thought you would get at maturity, your leverage, your unlimited return, it doesn’t matter anymore,” he said.

Usually those notes, combining growth and a call feature, are shorter in duration. But when it is the case, the downside protection is not as extensive.

Tradeoff

“Five years out we may be in trouble if we need protection. What are the odds of getting called a year from now at 8%? I would give it 50/50. That means you miss some of the upside,” he said.

Doucette expressed a bullish view over the five-year term.

“I’d probably reduce the buffer to 10% to increase the leverage.”

But after one year, the note is likely to be called. Raising the call premium may be an option too, although this adviser did not think it was the right one.

“I’d rather boost the leverage at the end, not the call premium,” he said.

Part of his reasoning was that the true benefit of those structures lies in the growth potential at maturity. The other factor was based on the limitations imposed by pricing.

“Your leverage will go up further than your cap. Five years out, it’s going to be cheaper to increase the leverage,” he said.

Restructuring the notes could be a complicated process, he said.

“There are so many ways to go. You can play with the tenor. You can change the size of the buffer. You can adjust the leverage; you can modify the call premium,” he said.

Adjusting the amount of call premium though was not a factor for Doucette.

“Eight percent is a terrible return. Getting an additional 1% or 2% doesn’t do anything,” he said.

Among all the possible variables to play with, increasing the leverage was his favorite option.

It is what it is

But Doucette may not even be interested in re-arranging the terms because the foundation of the structure is the one-time call after one year.

“That’s the set up and that’s how they can give you no-cap plus leverage at maturity.

“If you don’t get called, great. But the odds are against you.

“I don’t like these notes. You’re buying it as an equity substitute. But you end up with income.

“If you get called at 8% and the market is up 20%, you missed the upside and you missed the leverage.

“I’m not a big fan of trading uncapped leveraged return for a call premium that is not spectacular,” he said.

The size of the deal, he conceded, was notable. But he was not surprised by it.

“It’s probably being sold, not bought,” he said.

Catapult

A market participant explained that the structure was flexible and could be changed to accommodate different market views.

“Some issuers call those callable growth notes catapults. It’s a funny name. But what’s nice about them is that they’re configurable by investors,” he said.

“You could get a higher call premium and a lower return at maturity. All those deals are uncapped, but you could get less leverage.

“For instance, yes, you could capture a 12% call premium but get only 1.5x leverage. That 20% difference could have a significant impact on your return.

“And of course, you wouldn’t have a 20% buffer.”

Something for everyone

Most of the time, investors use those notes for the call premium, he said.

“They’re looking for that juicy 10%, 12% call premium. They don’t want that bullet. Investors want the optionality,” he said.

Other investors are attracted to the notes for the uncapped leveraged upside at maturity, he said.

“For those people, the call is some kind of a risk they’re willing to take to get the full upside.”

“The beauty of structured products is that they can be customized to fit any investor’s outlook.

“It all goes back to your outlook,” he said.

Scotia Capital (USA) Inc. is the agent. UBS Financial Services Inc. is the selling agent.

The notes settled on Wednesday.

The Cusip number is 06418A803.

The fee is 2.5%.

© 2015 Prospect News.
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