Scotiabank’s capped notes tied to EAFE show ‘tiny’ geared buffer, double-digit potential gain

By Emma Trincal

New York, Aug. 10 – Bank of Nova Scotia plans to price 0% capped buffered enhanced participation notes due in 19 to 22 months linked to the MSCI EAFE index, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 1.5 times any index gain, up to a maximum payment of between $1,172.05 and $1,202.20 per $1,000 principal amount.

Investors will receive par if the index falls by up to 5% and will lose 1.0526% for each 1% decline beyond 5%.

For bulls

“This is a cute, tiny little buffer. But it may be handy. You think it’s likely to go up but you’re not sure. So even 5% is better than no buffer,” said Steve Doucette, financial adviser at Proctor Financial.

Since the cap and the tenor are disclosed in a range, Doucette picked the best scenario – the shorter maturity of 19 month and the highest cap at 20.20%.

Under this assumption, investors may expect to get up to 12.75% a year compounded.

“Anytime I see more than 10% return on the upside, clients are going to be happy. So we like it,” he said.

“That’s when you need to look at the protection side. Am I an optimist and do I think we can turn the corner after a correction? Look, we have momentum, the economy is pretty good. This market could run for the next couple of years.

“If that’s your view then the terms are in your favor. And if you’re wrong, you still get a little bit of protection.”

Inoffensive gear

Doucette was not concerned by the small size of the buffer although he said he found it unusual.

“I haven’t seen a 5% buffer, let alone with downside leverage,” he said.

But the gearing was not a drawback for him.

“You’re still ahead. This one is so small, it’s going to take even more time to take you down,” he said.

“Nobody wants to be levered down. But it’s so marginal and you still outperform on the way down.”

More importantly: the small downside protection allowed the issuer to price a “decent cap” with leverage, he concluded.

Specifics, please

Matt Medeiros, president and chief executive of the Institute for Wealth Management, had a different opinion. To him, a direct investment in the index fund would be a better alternative to this product.

“I am struggling to understand how this particular note makes sense,” Medeiros said.

“I like the underlier but if I want to invest through a note, I would certainly want a more substantial buffer.”

The fact that two of the terms of the product were stated in a range rather than defined was also a source of disappointment.

“If I wanted to make a final determination, I would want specific terms regarding the maturity and the cap.

“At this point I would say it’s an idea but not an investable idea.”

Cap versus buffer

The risk-adjusted return was his main concern. The cap, even on the highest end of the range, was not “acceptable” for this particular index, he said.

“A 5% buffer with this index is really insignificant relative to the fact that a 5% pullback could happen in a week,” he noted.

“We like this index. We think it has upside potential.

“This is why we think the cap is not acceptable. The buffer is too low relative to this cap.”

The high credit quality of the issuer may explain the “weakness” of the pricing, he said.

“Canadian banks have tighter spreads and that’s the implied reason, for sure.”

Scotia Capital (USA) Inc. is the underwriter with Goldman Sachs & Co. LLC as dealer.

The Cusip number is 064159JZ0.

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