Advisers compare terms of two BNP Paribas’ autocalls with uncapped upside participation

By Emma Trincal

New York, July 12 – BNP Paribas is planning to price two issues of notes providing an automatic call after one year and in the absence of it, uncapped leveraged participation at maturity.

The structure employed in both deals has become one of advisers’ favorites. Several issuers have already priced similar notes, such as GS Finance Corp., Citigroup Global Markets Holdings Inc. and HSBC USA Inc. among others, according to data compiled by Prospect News.

The two BNP deals have similarities, for instance the uncapped leveraged exposure on the upside and the autocall after one year. The main differences lie in the tenors, the exposures (single asset versus worst-of) and the type of downside protection offered. Advisers expressed their respective preferences based on such differences.

Three- and five-year

The first deal – 0% autocallable buffered return enhanced notes due July 29, 2025 – offers the shorter term.

Returns are tied to the worst of two ETFs: the SPDR Gold Shares and the Energy Select Sector SPDR fund, according to a term sheet. The call strikes at 80% of the initial price after one year and triggers a call premium of 9%.

If the notes are not called, the payout at maturity is 2x the return of the worst performing fund. The buffer amount is 15%.

The second issue – 0% autocallable leveraged notes due Aug. 3, 2027 linked to the S&P 500 index – is two years longer. After one year, the 9.5% call premium is paid if the index finishes at or above its initial level.

If the notes are not called, the payout at maturity will be par plus 2.6x the gain of the index.

A barrier rather than a buffer is set at 70% of the initial price.

Oil, a red flag

“The first one on gold and energy is more interesting but I would probably recommend the second one to my clients,” said Tom Balcom, founder of 1650 Wealth Management.

“The problem with the first one is oil. Even though XLE [Energy Select Sector fund] is already down more than 25% from early June, any cease-fire between Ukraine and Russia, any conflict resolution could precipitate a much deeper decline in oil prices.”

Step-down

The “oil risk” was one of the reasons Balcom said he preferred the five-year note although the three-year product offered some attractive features, such as the step-down used for the autocall.

“I like having a chance to be called at 80% rather than 100% of the initial level. Again, the price of oil is the greatest issue. If you don’t get called, you may very well breach that 15% buffer and lose money there,” he said.

For Balcom, the automatic call after one year was the ideal scenario. The greater likelihood for an early redemption due to the lower call threshold was what made the three-year note “interesting,” he said.

“I’d rather get called at 9% than risk a loss at maturity. 9% is a juicy return compared to alternatives in fixed-income,” he said.

Gold and inflation

Balcom was not very bullish on gold.

“People buy gold as a hedge against inflation. But if you look at the chart, the fund has reached a peak in March at 193 and it’s now trading at 160. During that time, rates were rising, inflation was spiking...How is that an inflation hedge?” he said.

The SPDR Gold Shares tracks the gold spot price.

While the gold fund is a pure commodity play, Balcom was mostly concerned about a sharp drop in oil prices, which would directly impact the value of the other underlier, which tracks the energy sector of the S&P 500 index.

“The riskiest ETF is the oil fund. The outcome of the Ukraine war is definitely a big unknown. Oil prices can make huge moves,” he said.

S&P preferred

While the three-year note was attractive, Balcom said he would pick the five-year product. He explained why.

“It’s on the S&P. The S&P is easier to explain. Everybody understands what it is. I also like that it’s not a worst-of. That makes it easier to explain too.”

The notes have a barrier, not a buffer, but Balcom said he was “happy” with the existing barrier given the amount of protection offered.

“A 70% barrier is better than a 15% buffer in my view. I always prefer larger protections. Even if it’s not a buffer, you have twice the amount of protection here. I like it better,” he said.

No to the worst-of

Steven Foldes, wealth manager and founder of Evensky & Katz / Foldes Financial Wealth Management, also preferred the five-year S&P 500-linked notes.

“I would usually pick the shortest duration, but, in this case, I would choose the five-year one because it’s on a single index.

“The other one is a worst-of. Not only that: it’s based on two very uncorrelated assets,” he said.

The coefficient of correlation between the two underlying ETFs is 0.39.

Another advantage with the second deal was the higher leverage multiple of 2.6 instead of 2, he noted.

Foldes said that the uncapped leveraged return at maturity offered the best outcome compared to the autocall scenario.

“You want to benefit from the 2.6x leverage with no cap, especially from where the S&P is right now. That’s why I wouldn’t want a term that makes it easier to get called like this lower trigger at 80%,” he said.

Entry point

There was one caveat with the barrier notes: the 30% contingent protection was “unnecessary” for a five-year term, he said.

“I would much rather give up this barrier and have more leverage or alternatively, get a shorter duration, like three or four years,” he said.

A barrier in both cases was probably pointless because of the recent pullback, he said.

“We’re starting from such a lower base, I’m not too worried about having no downside protection even three years from now,” he said.

The S&P 500 index, which closed on Tuesday 20.8% off its Jan. 4 high, is technically in a bear market.

Fees

Finally, the five-year note offered another advantage in terms of cost, noted Foldes. Its fee is 1.1250% versus 2% for the three-year product, according to the term sheets. On a per-annum basis, the fee for the five-year is 0.225% compared to 0.66% for the three-year.

“As much as I dislike longer-dated notes, I’d much rather have the longer one in this case. The very reasonable fee is another reason,” he said.

Creditworthiness

Foldes said he was comfortable with the issuer’s credit in both deals.

The five-year credit default swap rate for BNP Paribas is 76 bps, according to Markit. In the U.S., spreads are much wider. JPMorgan’s 95 bps, for instance, are the tightest spreads among big U.S. banks, according to Markit. On the other end of the spectrum, Goldman Sachs’ CDS spread rates are 126 bps.

“I’m surprised to see BNP’s CDS spreads so tight. You would think they would be wider with everything that’s going on in Europe,” he said.

“Clearly, I have no problem using BNP as an issuer.”

BNP Paribas Securities Corp. is the agent for both deals.

The Cusip number for the three-year notes tied to the two ETFs is 05601WVZ1.

The deal is expected to price on July 26 and settle on July 29.

The Cusip number for the S&P 500 index-linked notes is 05601WW80.

The trade date is expected to be July 29 and the issue date Aug. 3.

© 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.