RBC’s $4.96 million absolute return autocalls on Levi Strauss show unusual payout at maturity

By Emma Trincal

New York, March 8 – Royal Bank of Canada’s $4.96 million of 0% trigger absolute return autocallable notes due March 6, 2025 linked to Levi Strauss & Co. provide a competitive call premium based on a slightly different payout structure at maturity, a structurer said.

The notes will be called at par of $10 plus an annualized call premium of 15% if the stock closes at or above its initial share price on any quarterly observation date, according to a 424B2 filing with the Securities and Exchange Commission.

If the stock finishes at or above its 60% downside threshold, the payout will be par plus the absolute value of the return.

Otherwise, investors will be fully exposed to the stock’s decline from its initial share price.

A bit different

Brady Beals, director, sales and product origination at Luma Financial Technologies, focused on the payout at maturity in the absence of a call event.

“That’s pretty interesting. Maybe the investor or the adviser has some conviction or probably a position,” he said.

“They’re bullish but the absolute return is a hedge.”

The barrier at maturity capped the absolute return on the downside and set the limit of the contingent protection as any barrier.

“It looks like an airbag. But it isn’t,” he said.

No jump, absolute return

Airbags are notes in which the barrier has a double role of protecting the downside while serving as the strike for the upside.

“With an autocall triggered at 100, the airbag would drop your last call trigger to the principal repayment barrier level at maturity, in this case from 100% to 60%,” he said.

The RBC structure is different, he argued, because above 60%, investors will not receive a fixed return but the absolute return, which requires the stock to move up or down. While in theory, investors could score as much as a 40% gain on the downside, they may also earn a limited return or even nothing if the stock moves are small or non-existent, he said.

Pricing rationale

“Since you may not get as much as you would with the airbag, the structure is less expensive to price. That’s why you’re getting a high return of 15%,” he said.

Another positive for pricing was the 2.8% dividend yield of the underlying stock.

“The higher your dividend yield, the better terms you can get,” he said.

He also pointed to the lack of any call protection.

“You can be called on the first quarter. It may also help pricing.

“Usually those deals carry a one-year no-call for tax purposes. Tax-efficiency may not have been the main focus here,” he said.

Recession risk

Taking into account the stock’s fundamentals and the macroeconomic picture should also be part of the due diligence process, said a financial adviser.

“It sounds like a good deal. But without knowing the financials of the company, I couldn’t assess the risk properly. The structure looks good, but you have to think of what could cause the stock to drop 40%,” said Lance Roberts, chief investment officer at RIA Advisors.

“With rates much higher and if we have a recession, smaller companies will be particularly vulnerable. A risk of bankruptcy could push the stock down 40%.”

With a market capitalization of $1.65 billion, Levi Strauss falls under the small-cap category.

“20% of the small-cap stocks in the Russell 2000 will have problems refinancing their debt because of sustained high interest rates in the economy,” he said.

“I’m not saying that Levi Strauss is one of them. But a recession leading to a consumer spending slowdown could hurt the bottom line of a company like Levi Strauss especially if they have a hard time refinancing their debt.

“The big risk going into next year is going to be the increase in borrowing costs for small businesses.”

Short track record

The stock of the apparel company began trading on NYSE Arca on March 21, 2019 at $17 a share. It peaked at around $24 in April 2021 before dropping to $13.57 in October of last year. The stock closed at $17.11 on Wednesday, almost at the same level as its IPO price.

Within its four-year history, Levi Strauss has already “breached the barrier,” in April 2020. The 60% level was set at $10.62 on the trade date based on an initial price of $17.70.

The limited information on the price action may constitute another risk, said Roberts.

“You don’t have the trading history to look back,” he said.

Rarely used

Levi Strauss is a relatively uncommon underlier for structured notes, according to data compiled by Prospect News.

Only 17 deals have priced on this name since the company went public for a total of $18 million, the data showed.

JPMorgan Chase Financial Co. LLC priced the largest one in July 2021 for $5.44 million. It was an issue of 13-month autocallable contingent interest notes paying a 13.65% coupon with a 75% barrier.

RBC’s recent offering is the second one in size in this small group.

RBC Capital Markets LLC is the agent and UBS Financial Services Inc. is handling distribution.

The notes settled on March 2.

The Cusip number is 78016M174.

The fee is 1.5%.

© 2015 Prospect News.
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