Wells Fargo’s autocallables linked to SPDR S&P Oil ETF have high coupon, but call is likely

By Emma Trincal

New York, Sept. 18 – Wells Fargo & Co.’s 0% market linked securities – autocallable with contingent coupon and contingent downside due Sept. 24, 2019 linked to the SPDR S&P Oil & Gas Exploration & Production exchange-traded fund offer an attractive coupon, but advisers said they are concerned about an early call, which would reduce the benefit of having a high coupon from two years to six months.

The notes will pay a contingent quarterly coupon at an annual rate of 9% to 10% if the fund closes at or above its 75% threshold on the observation date for that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par if the fund closes at or above its initial level on any quarterly observation date from March 2018 to June 2019.

The payout at maturity will be par unless the fund finishes below its 75% threshold, in which case the payout will be par plus the return with full exposure to losses.

Volatility

Carl Kunhardt, wealth adviser at Quest Capital Management, said he is not sure the notes would be a good fit for his clients.

“I’m not particularly bullish on a sector that’s going to be price-constrained for the foreseeable future,” he said.

“With fracking and new technologies, we are now actually producing more oil than we are consuming in the U.S.”

The underlying ETF is an equity fund, but its value is closely related to the price of oil, he noted. This correlation makes the share price highly volatile.

From its five-year high in July 2014 to its low in February 2016, the fund dropped 70%. It has since recouped some of its losses but has declined again this year by more than 22%.

“This note does not offer any upside participation. The only reason to buy it is for the coupon,” he said.

“I don’t see why I would choose one of the most volatile sectors in the market to generate a coupon. I don’t think it’s going to do well.”

At the same time, given how volatile the underlying fund is and how much the share price has already declined, investors should consider an automatic call on the first observation date in six months as very likely.

“I just think you need to have a strange view on the underlying. You sort of need to hope that it won’t do well, otherwise you’d be called, but you hope that it won’t be doing badly. You only benefit if it doesn’t do well but not terribly bad.

“It’s a strange view to have. That’s not my approach to how to make money.”

First call

Michael Kalscheur, financial adviser at Castle Wealth Advisors, said that the autocallable outcome would not be favorable to investors seeking income.

“There are some issues here, and it starts with the choice of a very volatile index,” he said.

“Chances are you’re going to be called in six months. Yes, it’s 5% in six months, which isn’t bad, but it’s not the kind of notes we usually recommend our clients.

“We’re not trading structured notes, just like we don’t trade stocks and we don’t trade mutual funds.

“Our goal is to hold things for three or five years, not six months. ... Six months is a lot of work for us to research things. We don’t play that game.”

That said, other features in the notes are attractive, he noted, citing the credit quality of the issuer and the “decent payment.”

Barrier

However, the risk at maturity remains high because of the volatility of the fund.

If for instance the notes were never called, investors would at best collect the 10% coupon per year. But a drop in the underlying at maturity could be significant given its volatility and back-tested performance.

“That would be the best of the worst-case scenario. You made 20% in coupon, but the fund is down 35% or 40% at the end. You’re still down a lot,” he said.

“That’s if you get the coupon all the time. But you probably won’t. At maturity, all you have is a barrier, not a buffer. And that’s a lot of risk with that type of index.”

For Kalscheur, the main drawback is the choice of the underlying.

“It really has to do with the choice of the index. I am not crazy about the risk and the volatility of the sector. And getting called so quickly would not be something we would want for our clients.”

Wells Fargo Securities, LLC is the agent.

The notes will price on Tuesday and settle on Friday.

The Cusip number is 95000E3C1.

© 2015 Prospect News.
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