Too much headline risk in RBC worst-of autocalls on Apple, Wells Fargo, advisers say

By Emma Trincal

New York, Feb. 8 – Royal Bank of Canada plans to price autocallable contingent coupon barrier notes due Feb. 12, 2021 linked to the least performing of the stocks of Apple Inc. and Wells Fargo & Co., according to an FWP filing with the Securities and Exchange Commission.

The notes will pay a quarterly coupon at an annual rate of 8.9% to 9.9% if each stock closes at or above its coupon barrier, 70% of its initial price, on the applicable quarterly observation date. The exact coupon rate will be set at pricing.

The notes will be called at par plus the coupon if each stock closes above its initial price on any quarterly observation date, starting on Aug. 9.

The payout at maturity will be par plus the final coupon unless either stock finishes below the 70% trigger price, in which case investors will lose 1% for each 1% that the lesser-performing stock’s final price is less than its initial price.

Barrier

“I usually like these worst-of autocalls. They can give you a decent coupon. But we like them on broader indices with a nice barrier,” said Steve Doucette, financial adviser at Proctor Financial.

Betting on single stocks is not part of his firm’s practice in general, he noted.

“How quickly can that 30% come upon you? When it happens you’re not collecting the coupon and you have unlimited downside at the end if you’re below.”

Virtual barriers

Apple closed at about $155 a share on Thursday. The barrier would be crossed at approximately $108, a price not seen since November 2016, according to the chart. Wells Fargo, which closed at $55 on Thursday, would show its barrier level – down 30% from its current price – at $38.50, a price last hit in May 2013.

“So much can happen to one of those two individual companies especially in the course of three years,” he said.

Shrinking fan club

Doucette’s main objection was the company risk associated with each security.

“Fundamentally, I’ve been a fan of Apple. But technology-wise, the company has made some serious mistakes. How long will they retain their brand and the loyalty of their customers as they keep forcing people to update their phones and spend more and more money on faulty devices?

“At some point, people are going to be tired of complaining. They won’t be willing to pay those huge premiums forever.”

Fake accounts

Wells Fargo had its own set of problems.

In response to “recent and widespread consumer abuses and other compliance breakdowns, “the Federal Reserve Board said in a press release on Feb. 2 that it would restrict the growth of the firm “until it sufficiently improves its governance and controls.”

“There’ve been bad headlines around those millions of fake accounts. Nothing ever surprises me in the brokerage industry,” he said.

Market risk

But market gyrations are increasingly concerning too, especially in the recent days. On Thursday, the Dow Jones industrial average plunged another 1,000 points, entering officially into a correction due to a 10% drop from its Jan. 26 high.

Doucette said he is more comfortable with broad benchmarks because of their inherent diversification.

“When the market dropped 36.5% in 2008, it was an average. Some names dropped much more,” he said.

Wiped out by successive write-downs, some bank stocks for instance lost over 90% of their value between early 2008 and March 2009.

Bond replacement

When buying those worst-of notes, Doucette said his goal is to generate income.

“If I was using it as an equity substitute I could stick with the 70% barrier. But since I buy those as a fixed-income replacement, I would push for a lower barrier,” he said.

If he had to “reconstruct” the note based on his own preferences, he may want to explore what type of contingent coupon he could get out of a 60% barrier.

But as it is the current structure lacks enough appeal from a risk-adjusted return.

“You’re taking a bit too much risk for a 9.5% coupon,” he said.

“It’s an effective way to get income. But it’s too far tilted with company risk.”

Low correlation

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he was not comfortable with the relationship between the two underlying stocks – one in the banking, the other in the technology sector.

“These two securities don’t share a high correlation,” he said.

“They could go in opposite directions. Meanwhile your return is linked to the worst of the two.”

If none of the two stocks falls, another problem would emerge: the automatic call. Medeiros said that it was not a good outcome in his view.

Reinvestment risk

“Presuming that at this point the market doesn’t have a prolonged erosion of value, this note would be calling in a short period of time,” he said.

“Do I like the idea of getting half of 9% in six months? Not particularly. Not if I’m trying to generate some income form my clients. I’d have to go back to the drawing board.”

Overall, managing risk with two stocks without knowing which of the two investors will be exposed to was not enticing, he said.

Risk management

“You can’t guess those things. But if I had to, I would be inclined to say that it’s easier to understand and calibrate the risk of Apple because it’s an earning question. Wells Fargo is a little bit harder to determine because there is more than just earnings risk,” he said.

“Either way you don’t know what your exposure is going to be until the end. This makes your risk management process a little bit too difficult to manage.”

RBC Capital Markets, LLC is the agent.

The notes will price on Friday.

The Cusip number is 78013XFF0.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.