Bank of Montreal’s $1.25 million notes on SPDR S&P Regional Banking offer buffer, sector bet

By Emma Trincal

New York, March 28 – Bank of Montreal’s $1.25 million 0% buffered bullish notes due April 28, 2017 linked to the SPDR S&P Regional Banking exchange-traded fund offer investors access to a niche market, the regional banking sector, but the focus may have been too narrow for investors preferring broad-based indexes. Also the upside was considered disappointing by some of the more bullish advisers.

The payout at maturity will be par plus any fund gain, up to a maximum redemption amount of $1,145 for each $1,000 principal amount of notes, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the fund falls by up to 10% and will have 1-to-1 exposure to losses beyond 10%.

“This note is attractive, for sure, but I wouldn’t do it,” Carl Kunhardt, wealth adviser at Quest Capital Management, said.

“I simply don’t do sector investing. My only exception is the health-care sector right now due to industry trends, but only for some aggressive portfolios.

“Otherwise, I avoid sector bets. I learned my lesson in 1998-99 when I did great for two years ... and then we all know what happened to technology stocks. ... Never again.”

Underlying

However, Kunhardt said he likes the notes themselves.

“I like the one-to-one with a real buffer. I’d like to see a bigger buffer, but 10% is fine, especially on a point-to-point. You don’t really have to worry about the ups and downs in between.”

The use of a regional bank fund or index was seen as more attractive than the larger universe of U.S. banks including the giant institutions.

The ETF replicates the performance of the S&P Regional Banks Select Industry index and represents regional banks such as Zions Bancorporation, M&T Bank Corp., First Republic Bank, KeyCorp and SunTrust Banks Inc.

Small versus big

The underlying fund is not as frequently used as the more common SPDR KBW Bank fund, which includes the big banks as well.

So far this year the S&P Regional Banks Industry index has only appeared in one other deal, a $7 million offering from Canadian Imperial Bank of Commerce, while the SPDR KBW Bank fund has been used in four transactions totaling $20 million, according to data compiled by Prospect News. But some believe that the regional bank fund may be gaining traction.

“Folks like the regional bank ETF at the moment because those banks are more tied to strictly lending. If rates go up, they’re more likely to benefit,” said an adviser.

Kunhardt agreed.

“I always prefer the regional banks where you can walk directly to the president or the vice president’s office because they’re pure banks. They do lending, and that’s it. Once you get into the national banks, you’re talking about a myriad of businesses – traditional banking but also investment banking, broker-dealers, a bunch of hedge funds, huge mortgage conglomerates, asset management, real estate portfolios. It’s everything.

“Having so many lines of business gives you more diversification, but it’s a two-edged sword. It means the bank has less focus. It also means that one line of business can take you down like the mortgage business did in 2008.”

Upside

Steven Foldes, vice-chairman of Evensky & Katz/Foldes Financial Wealth Management, was critical about both the underlying and the structure.

“We don’t typically buy an individual sector. So for us, this would be a non-starter,” he said.

But even if the underlying were acceptable, the terms on the upside would not have met the adviser’s bullish criteria, who said that a cap without any form of return enhancement is peculiar.

“Having a downside protection is always nice. But having a 14.5% cap really precludes you from getting any significant return in the event that the asset class takes off,” he said.

Such scenario may be likely to occur given the poor performance of the ETF, already down 10% for the year, he added.

“If there is a bounce back, why would you want to have the cap?”

Market view

“The only reason I would get into this note is because I’m bullish. But I’m not getting anything on the upside, so what’s the point?”

Even a mildly bullish investor would not benefit much from the payout.

“If I think the share price is only going to be up a little bit, I’m going to need leverage. The one-to-one exposure is not going to help me.

“If I’m bearish, obviously I don’t want to buy the notes. Even 10% would not be enough.

“When I buy bullish notes, I want to see either an uncapped underlying or a leveraged underlying with a higher cap.

“This doesn’t make much sense to me. I’m not sure where this fits on the spectrum of the investor’s view of the asset class.”

The notes (Cusip: 06367TCF5) priced on March 22.

BMO Capital Markets Corp. was the agent.

The fee was 1.5%.

© 2015 Prospect News.
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