TD Bank’s $45.13 million notes on Stoxx Banks show 4x leverage, eye-popping cap

By Emma Trincal

New York, Nov. 9 – Toronto-Dominion Bank’s $45.13 million of 0% leveraged capped index-linked notes due Feb. 5, 2024 tied to the Euro Stoxx Banks index presented an unusually favorable upside payout with 4x leverage up to a 48.92% cap. Investors will be fully exposed to any index decline, according to a 424B2 filing with the Securities and Exchange Commission.

Mark Dueholm, chief fixed-income trader at Landolt Securities, who caters to conservative investors, paid more attention to the risk than the gain potential.

Full downside risk

“There is zero protection on the downside. It’s a big gamble. I don’t know why anybody would do that,” he said.

If the index is up 12%, you’re going to cap out. Sure, it’s a very high cap. But it doesn’t mean the risk-reward is attractive.”

Short-term leveraged capped notes with full downside risk are not uncommon. Each month, BofA Securities prices block trades following this script, which it calls “Accelerated Return Notes. Tied to broader indexes, however, their caps and leverage multiples never come close to the terms offered by TD Bank in its $45 million deal last week.

The same issuer for instance priced last week $15.27 million of Accelerated Return Notes due Dec. 29, 2023 linked to the Euro Stoxx 50 index. The notes were distributed by BofA Securities, Inc.

The payout at maturity was triple any index gain and the cap, 29.8%.

“To be sure a 45% cap with 4x leverage makes a lot more sense. I still don’t like the risk though, especially on such a short tenor. If the market falls hard, you have no time to recover,” said Dueholm.

Spectacular return

Steven Foldes, wealth manager and founder of Evensky & Katz / Foldes Financial Wealth Management, held a different view.

“Four times leverage with a short tenor of 15 months and a nearly 50% cap is very attractive,” he said.

“Even with a spectacular return in the European markets, which would likely happen in the event of a resolution between Ukraine and Russia, a nearly 50% return cannot be criticized especially in light of such a high multiple. Four times would take a modest return into a spectacular one.”

“It is a very attractive note assuming the credit worthiness of the bank allows me to go forward since I’m not familiar with the name.”

Another caveat was the 1.19% fee, which he said appeared to be “on the high side.”

Yield machine

A financial adviser, who is familiar with the underlying index, said he could understand why the terms were so attractive.

“It’s a terrible index. Issuers have used this index a lot to enhance returns because dividends are so high,” he said.

The dividend yield of the Euro Stoxx Banks index is 7.41%.

“People in Europe buy this index as a yield vehicle. Three-quarters of the returns come from the dividends. The price return doesn’t move upward. It moves sideways, in zigzag, and it has been moving that way for a long period of time. Overall, it has been trending down,” he said.

Value trap

Stripping the dividends did not just put a lid on the index performance.

“The total return with dividends is your buffer. It’s your 7.5% buffer. The notes don’t give you that. When you extract the dividends and if they don’t give you a buffer or a barrier, you’re long the downside,” he said.

Since the volatility of the index is relatively low, the price of the call options is cheap, he noted.

“Pricing four times is not a miracle. It doesn’t cost much,” he said.

“The odds are against you. So, I’m not surprised that the terms are outrageous.

“Now don’t get me wrong: if you’re sure about what you’re doing, if you expect a run-up in European banks, great! If you’re right, you’ll look like a genius.

“Personally, I see this as a value trap.”

But for Foldes who likes out-of-favor asset classes such as European equities, which have lagged U.S. returns for some time, the 4x leverage and elevated cap were precious features.

“Having exposure to this particular part of the world is usually part of a globally diversified portfolio anyway. In a long position, you’ll get what you get on the index, which could very well be a low return. With the note you get 4 times the result to a very high cap. I’ll take my chances with the note,” he said.

TD Securities (USA) LLC and Goldman Sachs & Co. LLC are the agents.

The notes settled on Tuesday.

The Cusip number is 89114YFA4.

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