Scotiabank’s $82.41 million step-up autocallables on Euro Stoxx favored by pricing, momentum

By Emma Trincal

New York, Jan. 4 – Bank of Nova Scotia’s $82.41 million of 0% autocallable market-linked step-up notes due Dec. 20, 2019 linked to the Euro Stoxx 50 index benefited from the appeal European stocks have to momentum traders as well as from technical pricing factors associated with the underlying benchmark, sources said.

The notes will be automatically called at par of $10 plus a call premium of 14.75% per year if the index closes at or above the initial index level on Jan. 8, 2018 or Dec. 14, 2018, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called and the final index level is greater than the step-up value, 130% of the initial index level, the payout at maturity will be par plus the index return.

If the final index level is greater than or equal to the initial level but less than or equal to the step-up value, the payout will be par plus the step-up payment, 30%.

If the final index level is less than the initial level, investors will lose 1% for every 1% that the index declines from its initial level.

Credit

“The fact that it’s a Canadian issuer may have helped. People are getting more comfortable with these names due to their higher credit,” a market participant said.

“But honestly I don’t think people care as much about credit quality. What they want is diversification. As long as they have different names, different issuers ... they lower credit risk exposure that way.

“Merrill Lynch uses a variety of different issuers, and that’s key to their success.”

No protection

The three-year notes offer no buffer or barrier at maturity, but they are automatically callable on a yearly basis.

“The autocall itself doesn’t give you protection,” he said.

“People may hope that they’ll get called, but that’s just that: a hope. They may not get called.

“It was a deal with no downside protection, and given its size, people liked it a lot.”

No buffer, no problem

Investors may not be as reluctant to invest in unprotected notes as they have been before due to their familiarity with risk.

“Almost everything is principal-at-risk today,” he said.

“A buffer is not true protection anyway. If the index drops, all it does is make you go down a little bit less.

“You have the barriers, but by now, people understand the limitations of that too. Sometimes the barrier doesn’t help at all. If you breach, you’ll lose from the original spot.

“Investors are very used to it. When you buy stocks, you don’t get protection.”

Dividends

Both the 14.75% annual premium for the autocall and the 30% potential digital at maturity are attractive. While those products generate premium shorting volatility, the main “juice” behind the deal probably came from elsewhere, he said.

“Volatility on the Euro Stoxx is not much higher than on the S&P,” he said.

“I think this is more of a technical play. You have more yield with the Euro Stoxx. Optically, it gives you better pricing.”

He compared the two-year Constant Maturity Swap rates in the United States and Europe respectively with the benchmarks associated with the two regions.

For the United States, the two-year CMS rate is 1.5%. The S&P 500 index has a 2% dividend yield. The difference between rates and dividends is negative 0.5%, he noted.

In Europe, the two-year CMS is negative 0.2% while the yield on the Euro Stoxx 50 is 3.6%. The same formula gives a negative 3.8% difference between the rate and the yield.

“The 3.8% negative value for the Euro Stoxx is much greater than what we see on the S&P. The more negative it is, the cheaper the equity. ... That’s why from a pricing perspective, Europe is much cheaper. It’s optically much more attractive to price a note like this one on the Euro Stoxx.”

Buying up

For Paul Weisbruch, vice president of ETF/options sales and trading at Street One Financial, the main driver for the bid was momentum.

Looking at the Euro Stoxx 50 ETF, which trades on the NYSE Arca under the ticker “FEZ,” he noted that the fund is now trading at its highest level since September.

“It’s probably a momentum trade. People are rotating in it expecting further upside,” he said.

In general, the euro zone has “recovered” since the Brexit vote in the United Kingdom in June, he added.

“It’s one of the better-performing segments of the market right now.”

The share price of the ETF closed at $33.76 on Wednesday. It is up 15.7% from its one-year low in June of $29.18 The current price is a dollar shy of the April high.

“It looks like there’s a potential breakout from a technical standpoint. We’ve seen a lot of volume since the end of last week.”

Mood

Market sentiment and bullishness also had an impact.

“Global markets in general are trading very optimistically just on the prospects of a greater prosperity under a Trump administration,” he said.

“There’s a counterpoint to these headlines too, but we’re trying not to be political. Just look at Russia. Russian stocks are trading at new highs as well based on the same assumptions.

“If you’re political and disagree with the expectations, there’s a risk. You’re missing out [on] the rally.”

The notes (Cusip: 064160567) priced on Dec. 29.

BofA Merrill Lynch was the agent.

The fee was 2%.

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