Wells Fargo’s leveraged buffered notes linked to MSCI EAFE ETF offer strong buffer, lower risk

By Emma Trincal

New York, Sept. 16 – Wells Fargo & Co.’s 0% notes with leveraged upside participation to a cap and fixed percentage buffer due Oct. 2, 2018 linked to the iShares MSCI EAFE exchange-traded fund provide a very competitive level of protection, especially for a two-year term, said Tim Vile, structured products analyst at Future Value Consultants.

The payout at maturity will be par plus 1.5 times any fund gain, up to a maximum return of 14%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the fund falls by up to 20% to 24% – the exact percentage will be set at pricing – and will lose 1% for each 1% decline beyond the buffer.

Buffer

“It’s a nice chunky buffer for a 24-month product,” Vile said.

The 14% cap with 1.5 times on the upside provides investors with a 6.77% annualized compounded return.

“That’s not a lot, but if you are a bit bearish or simply a conservative investor, you don’t mind paying for the buffer by reducing the cap a bit.”

The structure of the notes reflect a consistent view on the market, he added. Potential buyers would include moderately bullish investors who do not expect strong market returns as well as cautious investors concerned about the risk of a correction.

Not for bulls

Bullish investors, on the other hand, would not be likely to consider the notes.

“A 14% cap on a two-year is too low for a bull,” he said.

It would only take the underlying fund rising by 4.55% a year in order to take investors to the 6.77% compounded annualized cap.

“It’s a very reasonable, modest expectation,” he said.

“This note could appeal to a wide range of investors, except strongly bullish ones,” he said.

“To make the product appealing to bulls, the issuer would have had to raise the cap, changing the entire structure.

“To get the most cap increase you’d probably have to reduce the buffer or increase the gearing on the downside.

“But this is not what this note has to offer, which is a solid downside protection.”

Market riskmap

Future Value Consultants provides research reports with scores on risk, return and price comparing each product to its peers, which would be leveraged return notes in this case, and against all products.

The firm calculates the market risk and the credit risk and adds the two components to generate the “riskmap,” which measures on a scale of zero to 10 the risk associated with a product with 10 as the highest level of risk possible.

The notes have a 1.42 market riskmap versus an average of 1.75 for the leveraged return product type, according to Future Value Consultants’ research report.

“Not a surprise. The risk is lower than average mainly because of the big buffer. Also, the underlying is not too volatile.”

The iShares MSCI EAFE ETF tracks the performance of the MSCI EAFE index, an equity benchmark for developed markets excluding the United States and Canada.

Credit

At 0.28, the credit riskmap is lower than the 0.46 average score for leveraged return notes, the report showed.

“This one has a lot to do with the issuer’s credit,” he said.

Wells Fargo has tighter spreads than most of its U.S. peers: its credit default swap rates are at 55 basis points, against 93 bps and 95 bps for Morgan Stanley and Goldman Sachs, respectively, and 79 bps for both Bank of America and Citigroup, according to Markit. The closest to Wells Fargo is JPMorgan with spreads of 61 bps.

The riskmap is 1.71, compared to an average of 2.21 for similar products and 2.33 for all products.

“This product is significantly less risky than average,” he said.

Risk-adjusted return

The return score measures the risk-adjusted return of a note on a scale of zero to 10.

The return score is 7.40, in line with the average of the same product type at 7.45. It is better, however, than the average for all products of 7.13, according to the report.

The score suggests that this product is in line with its peers in terms of expected return given the risk profile, he said.

“You have a low riskmap, which brings the score up. But the low cap punishes it,” he said.

Pricing

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10. This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

At 8.84, the price score is higher than the 8.76 average for the same product type, the report showed.

“Despite the low cap, there is a lot in this note. You have a 24% buffer, 1.5 times leverage. The cap itself is not horrifyingly low,” he said.

The duration of the notes also helped.

“Two-year is not really a short product in the leveraged return category. You often see leveraged notes in the 13- to 18-month range.”

A longer-dated product usually increases the price score as the fees calculated on a per-annum-basis will be spread out over a longer period of time, he explained.

Overall

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. The score is the average of the price score and the return score.

The product has an 8.12 overall score. This is nearly equal to its peers (8.11 average score for the category) but higher than the average for all products at 7.68.

“This is a decent product. The return score brings the overall down a little, but the notes should still be appealing to bearish investors. The main issue here is the cap, but it’s part of a trade-off: you agree to have a lower cap in order to get a big buffer and some good leverage.”

Wells Fargo Securities, LLC is the agent.

The notes will price on Sept. 27 and settle on Sept. 30.

The Cusip number is 94986RW49.

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