Wells Fargo’s S&P 500 notes designed for bullish investors looking to beat a slow market

By Emma Trincal

New York, March 2 – Wells Fargo & Co.’s 0% market-linked securities due March 29, 2021 linked to the S&P 500 index offer a return-enhancement feature with no cap on the upside and add contingent downside protection, making the notes attractive for the average investor, including moderate bulls who do not expect strong returns in the years ahead, a financial adviser said.

If the index return is positive or zero, the payout at maturity will be par plus the greater of the contingent minimum return and the index return, according to a 424B2 filing with the Securities and Exchange Commission.

The contingent minimum return is expected to be 40% to 45% and will be determined at pricing.

If the index declines by 30% or less, the payout will be par. If the index declines by more than 30%, investors will be fully exposed to the index’s decline from its initial level.

The minimum return and uncapped upside give different kinds of bulls an opportunity to profit from a market uptrend, sources said.

“The minimum return is very intriguing. That equates to almost 6% compounded return, far better than most bonds are paying today,” said Michael Kalscheur, financial adviser at Castle Wealth Advisors.

“The uncapped upside potential is very beneficial. The market is way up, I'm way up.”

He also saw other aspects of the deal as positive.

“Wells Fargo is an excellent credit. No concerns about tying up money for six years with them here,” he added.

“The underlying is the S&P 500; it’s an easily recognizable and understandable benchmark for clients.”

Finally, the 3.25% fees for six years are acceptable.

“It works out to be less than 55 bps per year; that’s very reasonable.”

The only drawback is the type of protection.

“The downside barrier is a problem. I know there have been five-year periods with the S&P down more than 30%. That being said, there's probably less than a 1% chance of that happening from this point forward. It's an obvious concern, but not a deal killer,” he said.

“This would not be an appropriate note for conservative investors, nor should it be a standalone investment.

“However, if used in conjunction with other buffered notes, I think this one would be very complementary.

“At the end of the day, this does accomplish my goal of winning two out of three times. Market is way up, I win. If the market is average, I win. I only lose if the market is down more than it has been in the last 40 years.”

Precious dividends

While a conservative investor may not feel comfortable with the barrier protection, a very bullish investor on the other end of the risk spectrum may not want to sacrifice the dividends over a six-year timeframe, a buysider said.

“I know Wells Fargo is a good credit, but six years is a long time,” he said.

“You’re only getting the price return, not the total return. Over a six-year period, you’re missing out on a lot of compounded return by not getting the dividends.

“The good news is even if the S&P is flat, you get at least 40%, which is 5.77% a year with compounding. But in order to get it, and that’s not much in my opinion, along with the 30% protection, you have to give up the dividends. If you’re bullish, I don’t think it’s worth it.”

Bullish case

This buysider examined the downside component of the structure first.

“That 30% kicks in in six years. If we’re down 30% in six years from what we’re at now, we’ll have bigger problems to deal with. I just don’t see that happening,” he said.

He took a six-year period from March 2004 to March 2010, which included the 2007-09 bear market. In that six-year period, the market declined by 3%.

“OK, so you would have had a loss. But that presupposes we’d have another crash. I just don’t see that happening,” he said.

“The U.S. stopped doing QE, and they’re talking about raising rates. Whether they do it in June or September, it means they’re much more confident about the economy. Meanwhile Europe is doing QE. ... They’re starting to juice their economy. China just lowered their rates. Japan is also trying to stimulate growth.

“The U.S. economy might be in the process of cutting back. But all the other central banks are on stimulus mode. Because all the global economies are so interconnected, I don’t expect another 2008-like crash.”

Total return

On the upside, getting the 40% minimum return is “not worth” giving up dividends, he said.

He looked at the S&P 500’s trailing total return averages over different timeframes and concluded that even the worst average produced a better return than the 5.77% annualized contingent minimum return offered by the notes.

“If you look back at the five-year average, you get 16%. Even if you take the lowest average, the 10-year at 8%, you’re still beating the 5.77% minimum return by 2%,” he said.

“Dividends represent a big component of total returns,” he noted, quoting a research paper published by Richard Skaggs, a portfolio manager at Loomis Sayles.

From the end of 1929 through March 2012, reinvested dividends provided almost half of the S&P 500’s total return, or a 9.4% annualized return versus a 5.2% return for price appreciation alone, according to the paper.

“Even though we’re looking at a six-year note, but these gaps in performance are pretty striking. If you’re bullish, you don’t want to miss that part of the gains,” he said.

Wells Fargo Securities LLC is the agent.

The notes are expected to price March 20 and settle March 27.

The Cusip number is 94986RWC1.

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