Wells Fargo's contingent coupon access securities linked to S&P 500 seen as bond alternative

By Emma Trincal

New York, Sept. 13 - Wells Fargo & Co.'s access securities with contingent coupon and contingent downside due September 2027 linked to the S&P 500 index are seen by financial advisers as bond-like products due to their long duration and the conditions in place to receive the coupon.

However, principal is still at risk. As a result, investors should first find out how liquid the notes may be on the secondary market before even considering the deal, they said.

The notes will pay a contingent monthly coupon of at least 7% if the index closes at or above the 60% trigger level on the observation date for that month, according to a 424B2 filing with the Securities and Exchange Commission. The exact monthly contingent coupon will be set at pricing.

If the final index level is at least 60% of the initial level, the payout at maturity will be par. Otherwise, investors will be fully exposed to the index's decline.

Michael Kalscheur, financial adviser at Castle Wealth Advisors, said that although the principal repayment is not guaranteed, the odds of losing capital at maturity are reduced by the combination of a long tenor and low final barrier.

It would take a lot

"If you assume that nothing worse than 2008-09 is going to happen over the next 15 years, this is the best bond you can buy," he said.

"I look at this as a 15-year Wells Fargo bond. Even at the depth of 2009, when the S&P was cut in half, there were only one or two months when you were down 40% from the high in 2008.

"If you take that last big bear market in 2008-09, it looks like the worst-case scenario would have been something like half a year during which you wouldn't have been paid.

"Over 15 years, I would be hard-pressed to find a place where the market was even down for such a long period of time.

"Obviously the big risk is what happens at the very last point. But take March 2009, the last market bottom, and go back 15 years before in 1994: it was a heck of a lot lower then compared to what it was at the depth of 2009."

The S&P 500 rose from 444 in March 1994 to 735 in March 2009, a 65.5% increase between the two lows.

"People talk about the 2000s as the lost decade. But this note is not 10 years; it's 15 years. And we're not just talking breakeven, but a 40% decline. You'd have to be a pretty big bear to believe that you're going to hit the 60% strike. It's possible, but I just don't see that as very likely. The 40% contingent protection over such a long period of time seems quite efficient," he said.

Kalscheur added that the long tenor of this structure is not necessarily a bad thing.

"Time is a positive in this one. Unless we are on the precipice of a Great Depression today, I don't think this 60% final barrier can be easily breached. You would need a serious depression in the U.S. wiping out the stock market, something like an 80% decline. The likelihood of Wells Fargo going belly up is higher than this doomsday scenario. I don't know anybody who is that bearish on the U.S. stock market," he said.

Kalscheur said that his market assumption allows him to consider the notes as a bond equivalent and to focus on the fundamentals.

Bond replacement

"I see this as a 15-year bond backed by Wells Fargo. You're not guaranteed 7%, but maybe you could average 6% or, more conservatively, 5½%. I would have to run the analysis. What's for sure is that I would look at this as a fixed-income replacement. This is not an equity play on the S&P 500. This is bond," he said.

The centerpiece of the analysis, according to Kalscheur, is to get a sense of pricing on the secondary market.

The first step in the analysis would be to estimate the potential coupon.

"What is the potential of getting 7% or 4%? And how does it compare to another 15-year Wells Fargo or some equivalent credit? Maybe the 15-year Wells Fargo is paying 4%, and this one could give you 6%. Is it worth it?"

Secondary pricing, which is hard to assess, is a very important piece of the reasoning, he said.

"The nice thing about buying a straight bond is that you can easily sell it on the secondary market. Structured notes are thinly traded relative to straight bonds. Am I going to be able to sell? Redemption would be my biggest concern," he said.

The prospectus said that, as with most structured products, investors should expect to sell their notes at the price the agent is willing to buy them. In addition, there may not be a secondary market.

Despite the uncertainty of secondary pricing, Kalscheur said that the notes have a place in some portfolios.

"People are starving for yields right now," he said.

"You wouldn't want to offer this to a little old lady or to the very risk-averse investor. But if you already have money in a floating-rate bucket, an international sovereign debt bucket or a high-yield bucket, if searching for yield is what you are doing, then it's a plausible solution. In fact, it's actually a good product for yield."

Price discovery

Steve Doucette, financial adviser at Proctor Financial, agreed that the product is designed for yield-seekers. But liquidity and secondary pricing would also be an issue for him.

"I would look at it as a bond component. It might be a way to collect a coupon," he said.

"But I'll never hold it for 15 years. It could be a way to collect 7% forever. But when I approach that 40%, I would want to exit. How much could I realistically sell it for if the market goes down 10%, 15%, 20%? I would need to have an answer to that."

Doucette said that the paid coupons, which can accumulate year after year, increase the downside protection.

"Everything that I have collected so far, I can use it as a buffer. I would have to go through a large level of market loss before losing my principal. Say the market is down by 20% after my first two years holding this note. I've collected 14%. I'm actually down only 6%," he said.

Despite the added cushion, Doucette said that he would still want to know what type of pricing he could get from a secondary transaction at this level.

"What will be the penalty I would have to pay? It all depends on the pricing of the options," he said.

Doucette said that he would not buy the notes for two reasons. First, a 15-year tenor is too long for his portfolio. Second, he would not want to invest in the long-dated product not knowing what type of secondary pricing he could get.

"But for investors looking for yield, you can collect the 7% annually for quite some time. You could in theory have 7% for 15 years. How many people wouldn't like that?" he said.

Wells Fargo Securities, LLC is the agent.

The notes will price and settle in September.

The Cusip number is 94986RLJ8.

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