TD Bank’s $3 million autocall coupon notes on S&P offer attractive income play, advisers say

By Emma Trincal

New York, Oct. 3 – Toronto-Dominion Bank’s $3 million of autocallable contingent interest barrier notes with memory interest due Oct. 13, 2023 linked to the performance of the S&P 500 index provide an above-average return, one that competes with worst-of notes, advisers said.

The notes will pay a contingent quarterly coupon at an annual rate of 14.5% if the index closes at or above the 80% contingent interest barrier level on the corresponding observation date. Previously unpaid coupons, if any, will automatically be included whenever a contingent payment is made, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par plus the coupon if the index closes at or above its initial level on any quarterly call observation date.

The payout at maturity will be par plus the final coupon unless the index finishes below the 80% barrier level, in which case investors will lose 1% for each 1% decline from its initial level.

Toward capitulation

Carl Kunhardt, wealth advisor at Quest Capital Management, said he liked the risk-adjusted return of the notes, part of the risk being covered by currently depressed market levels.

“It’s a one-year. I like that. I hate being locked in for a long time,” he said.

“It’s not a big barrier...20%. However, based on where we are, it doesn’t bother me.”

Kunhardt argued that the “cycle of market emotions” showed that the S&P 500 index was near its bottom.

The cycle of market emotions is a chart representing most common “sentiments” based on the ups and downs of the market. At the top is “euphoria” and “complacency” and toward the bottom lie “panic” and “capitulation.”

“We are very near the bottom of the market, very near the recession period when the market has already shed and is about to rebound any time,” he said.

“With the S&P already down 23%, the fact that the barrier is only 20% doesn’t seem as much of a headwind.”

Memory, coupon rate

The second positive aspect of the notes was the memory feature.

“Even if you breach the 20% barrier and miss your coupon on the first quarter, you’re going to get it back later, unless you have a sustained downside, which few people expect,” he said.

The note fit his view of an investment, which he defines as a “reasonable and rational expectation of a decent return.”

The size of the coupon was also very attractive compared to the historical 8% annual return of the S&P 500 index on average, he said.

“Anyone who thinks that 14.5% a year is not enough has a problem. It’s the S&P... Stop being greedy. Be real,” he said.

For Kunhardt, the structure struck the right balance between protection and upside potential.

“You can’t get a big barrier and a big return at the same time,” he said.

“They simply chose a higher-than-usual return and they pay for it with a smaller barrier. Given where we are in the market, it’s a good tradeoff.

“I actually like the note.”

Limited credit risk

Another financial adviser expressed a positive opinion about the product as well.

He first looked at the credit risk, finding nothing to be “concerned” about.

“Anytime I see a one-year note with that type of credit rating, I’m pretty happy with that,” he said.

Toronto-Dominion Bank is rated AA- by S&P Global Ratings.

“I also like that it’s not a worst-of. You’re getting a pretty high coupon for a note tied to the S&P. Those kinds of yields, you usually get them with a worst-of, not with the S&P as a stand-alone underlying.”

The notes may either get called or mature. If they mature, investors get exposed to market risk.

Looking at back-testing data on the S&P 500 index since 1950, this adviser found that the chances of a call were high and the risk of principal loss a maturity, low.

Getting called, paid

Over three-month rolling periods, the market has been up 66% of the time, he said based on his statistics.

“Two out of three times, you’re going to get called out in three months,” he said.

“In that short timeframe, you’re getting 3.625%. Not bad.”

The probabilities of receiving the coupon are naturally higher given the coupon barrier set at 80% as opposed to 100% for the call threshold.

Over a three-month timeframe, the S&P 500 index has dropped more than 20% only 1% of the time, he said. Over six months, the frequency rose but was only 2%.

“That means a chance of at least 98% of getting paid in the first six months,” he said.

“That’s a very strong probability of receiving your coupon and a fairly good chance of getting called out early or even later. Since you have the memory, you’re not losing anything.”

Cushion

This adviser also believed that current market conditions provide some margin of safety.

We’re already down 25%. Another 20% on top of that would bring you 45% lower from the highs. That would be kind of unusual,” he said.

The chances of the S&P 500 index finishing down more than 20% on any given year only happens every four or five years, he said. Adding the current 25% decline would lower the probabilities substantially.

For instance, over the last 40 years, the S&P has fallen by 30% or more on any given year only five times, he noted.

Risk-reward

“The odds in this deal work in your favor. I feel pretty confident about the risk,” he said.

“The memory and the size of the coupon more than compensate me for the risk.

“If it was an 8% coupon, I wouldn’t be interested. But here, at least you’re getting paid 14.5% to take that risk on. It’s worth it.”

Go-between

The only “negative” aspect of the deal was its cost, as disclosed in the filing.

“The 1% fee for a one-year note... It seems kind of high. I’m not sure why the fee is so high, but the terms are good,” he said.

This adviser had an idea about how to use the notes.

“If you have a skittish client sitting on the sidelines, this is a good go-between. You can get some equity type of return without the full equity risk. It may be the perfect vehicle to convince that type of client to put some money to work. I can see how the notes could be used,” he said.

TD Securities (USA) LLC is the agent.

The notes settled on Monday.

The Cusip number is 89114YDP3.

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