Homebuilders boost premium in UBS’ $1.16 million autocalls linked to indexes, homebuilders ETF

By Emma Trincal

New York, July 25 – UBS AG, London Branch’s $1.16 million of 0% trigger autocallable notes due July 26, 2027 linked to the least performing of the Russell 2000 index, the S&P 500 index and the SPDR S&P Homebuilders ETF deliver a high double-digit premium thanks to the use of a volatile underlying ETF tracking the homebuilding industry, advisers said. The lowering of the call premium below par helps mitigate risk, one of them noted.

The notes will be called at par plus a 16% annualized call premium if each underlier closes at or above its call level, 90% of initial level, on any annual observation date, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called, the payout at maturity will be par unless any underlier finishes below its 70% downside threshold, in which case investors will lose 1% for each 1% decline of the worst performer.

Step down

Jerry Verseput, president of Veripax Wealth Management, said the “step down” or lower call threshold constituted the main attractive feature of the note. Typically, automatic calls get triggered above, not below the initial price.

“It’s XHB that’s producing the big premium,” he said referring with “XHB” to the ticker of the SPDR S&P Homebuilders ETF.

“But what I really like about the note is the 90% call trigger.”

Verseput was relatively optimistic about the homebuilding industry.

“Over the next couple of years, XHB will be fine, especially if interest rates are coming down. That should help homebuilders,” he said.

The 90% call threshold made the notes slightly more “defensive,” he said.

As the 90% threshold increases the odds of a call, investors are less likely to lose money at maturity, he explained.

The so-called “snowball” structure in which investors get paid only when the notes are called was another positive aspect he pointed to.

“If you get called, you get a nice premium and your return is compounded,” he said.

A 16% annualized call premium will become 32% on year two, 48% on year three up to 64% at maturity, he noted.

“That’s a nice feature,” he said.

Peak

The downside risk would only be felt in the absence of a call.

“I would be nervous if it went through the four years because that would take me close to the next Presidential Elections. But I tend to think it will probably get called early because of the 90% trigger. This is really what I like about this deal,” he said.

Another additional risk was the current performance of the ETF.

“They chose to price the note at a time when homebuilders are close to an all-time high and this perhaps is a concern,” he said.

On the trade date, the ETF closed at $82.49 a share, setting the barrier level at $57.74.

“That would be where it was in November of last year. XHB is definitely what’s producing the big premium,” he said.

And yet, this adviser was not overly concerned given the structure of the notes.

“I can see XHB breaking the high and continuing to go up. Even if it doesn’t, it could certainly trade range bound. If it’s down, I can see it not dropping more than 10%, which would trigger the call. Again, that’s when the 90% really helps you.”

Toward lower rates

The fundamentals of homebuilders were also favorable to investors.

“I’m not too worried. There is still a pent-up demand for new homes and interestingly XHB has not slowed down even as interest rates have been rising,” he said.

The market is now entering a new phase.

“Investors believe that rates will decline because inflation seems to be headed down. Most people expect that the Fed will raise interest rates another quarter of a point another time and then stop.

“I’m not saying rates are going to fall any time soon. But over four years, they will, which will increase the odds of getting the premium for noteholders,” he said.

Commodity-like

Jonathan Tiemann, president of Tiemann Investment Advisors, said that the ideal and less likely scenario would be getting the full premium at maturity.

“But it’s unrealistic. The only way you could get that big premium would be if the market was down more than 10% each year, then back up. You’re more likely to get called and I’m sure that anyone holding this note is hoping to get called early,” he said.

The introduction of the homebuilders ETF and the worst-of payout explained the double-digit return.

“At first glance the risk profile of this note doesn’t seem terrible, especially with the call strike at 90. As long as all three are not down more than 10% you get your 16% per annum,” he said.

“But this third piece, the homebuilders ETF is what makes the note riskier than it first looked like.”

Tiemann expressed concern over the strong appreciation of the ETF, which has gained nearly 40% year to date.

“Homebuilders have significantly outperformed the S&P this year. They could do better if rates went down,” he said.

He also noticed that rising interest rates did not prevent the ETF share price from soaring.

“It’s as if homebuilders were not very interest-rate-sensitive. The ETF had a huge run despite the Fed’s rate hikes. You wouldn’t expect that.

“It’s probably because there is a shortage of supply in the housing market. Homebuilders behave more like a commodity than a bond,” he said.

Worst-of

Tiemann said he was not comfortable with the worst-of payout.

“This really makes it pretty risky. If any of the three is down more than 30%, you get exposure to the worst-of. If it was a single underlier, your risk profile would be the same as holding the position long. But because it’s a worst-of, you’re going to get the lowest performance,” he said.

The risk-adjusted return was also a drawback.

“You get a high premium because of the ETF and the worst-of. But your return is limited while your downside is not. I think you’re taking on too much risk,” he said.

Allocation

Finally positioning the notes in a portfolio may not be easy.

“It doesn’t fit in a fixed-income bucket because you don’t know if and when you’re going to get paid. It’s not an equity piece either because there’s so much going on.

“You may be getting a relatively high premium, but the risk profile is too high, and the complexity of the structure offers very little appeal. I would say it’s not my style of investing,” Tiemann said.

UBS Securities LLC and UBS Investment Bank are the agents.

The notes priced on Friday and will settle on Wednesday.

The Cusip number is 90279GYS2.

The fee is 0%.

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