Bank of Montreal plans three autocallables with high yield, American barrier, higher call strike

By Emma Trincal

New York, Sept. 8 – Bank of Montreal has announced the pricing of three separate cash-settled autocallable notes each linked to an exchange-traded fund. These products share a short tenor of one year, competitive coupons and attractive amounts of contingent protection. But the barrier type is based on a so-called “American” option, which means that the protection feature can be lost any time during the life of the notes as the option may be exercised any day.

Separately, the autocallable trigger is at a higher threshold than the initial price level, which is overwhelmingly used in most autocallables. Finally, the issuer introduced a four-month call protection feature.

The upcoming deal with the highest coupon and protection amount is Bank of Montreal’s 14.4% autocallable cash-settled notes with fixed interest payments due Sept. 30, 2016 linked to the SPDR S&P Oil & Gas Exploration & Production exchange-traded fund.

Interest will be payable monthly.

The notes will be called at par if the fund closes above the 110% call level on any monthly call date starting Jan. 26, 2016, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par unless the fund closes below the 65% trigger level at any time during the life of the notes, in which case investors will be fully exposed to any losses.

Different call

Tom Balcom, founder of 1650 Wealth Management, said the call protection until the end of January and the higher call trigger level at 110% versus 100% could both benefit investors.

“You can receive the coupon without worrying about being called away,” he said, explaining that some investors may want to be invested longer in order to retain income as long as possible.

“When the note is called early, the adviser has to find a home for the principal, which can be time-consuming. There are additional fees involved with reinvesting your principal.”

The yield, the short duration and the size of the protection are very “compelling” he said.

“They’re giving you a higher, juicy yield in exchange for some risk,” he said.

“You have to be bullish to believe the barrier won’t be breached at all for a year, but if you’re really bullish you would buy the ETF outright and you wouldn’t be concerned about protection.

“A 14.4% coupon is pretty high. Think about the 2.19% 10-year Treasury.

“You have a lot premium. Obviously it comes with risk.”

American barrier

Another aspect of risk in addition to the oil-related sector of the ETF is the American barrier used in the structure, he said.

“The 35% contingent protection is pretty solid, but it’s an American barrier. We prefer the European type,” he said.

A European barrier, which is most common with autocallables, is only observed once, usually at maturity.

“But an American barrier wouldn’t get you a 35% protection. It’s 35% as opposed to 25% or 20% because the likelihood of breaching the barrier is greater.”

Given the choice between a generous barrier observable throughout the life of the notes, such as this one, and a thinner barrier with only one observation date, he said he would choose the latter.

“I would go for the European barrier. You can have a flash crash and you hit the trigger. At any time, you can lose your protection,” he said.

“This deal doesn’t have that, but it has a very high coupon.

“Most everything in this structure is designed to offer a juicier yield. The trade-off is a higher probability to breach the barrier.”

Upside risk

Juin Chin, senior investment analyst of Modera Wealth Management, said investors would have to be familiar with these types of structures.

“This note has a lot of nuances, specifications. I can see complexity giving someone pause. There are a lot of conditions, parameters to keep track of,” he said.

“Having said that, this particular sector has been hammered and offers a lot of potential from a valuation standpoint.

“I am not too concerned about breaching the 35% barrier. To me, the risk is on the upside.

“The companies in this underlying fund index are mid-cap oil exploration companies. Those stocks are more volatile.

“A 10% move on the upside is very possible, and if it happens, you get called without getting your full return.”

In mid-June of last year, the fund hit a peak at around $83, and the share price is now a bit below $37 a share, he noted.

“It’s a more than 50% decline in 15 months. As of now, it’s already up 10% from the 52-week low.

“Considering how much the fund has already lost, I would worry more about missing on the upside than losing another 35%,” he said.

BMO Capital Markets Corp. is the agent.

The notes will price on Sept. 25 and settle on Sept. 30.

The Cusip number is 06366RZ73.

More to come

Bank of Montreal announced in the same offering documents two other issues of cash-settled autocallable notes.

The first one is notes linked to the iShares MSCI Brazil Capped ETF with a 13.8% coupon and a 70% barrier. The Cusip number is 06366RZ81.

The second one is based on the iShares Nasdaq Biotechnology ETF. The coupon is 10.2%, and the barrier is 80%. The Cusip number is 06366RZ99.

All three offerings are set to price on Sept. 25 and mature on Sept. 30, 2016.

BMO Capital Markets Corp. is the common agent.

The deals share the same characteristics: no autocallable feature prior to Jan. 26, 2016, a 110% call threshold, the monthly payment of a fixed coupon and the American type of barrier.

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