TD Bank’s $12.81 million of notes on Stoxx offer uncapped leverage over short tenor

By Emma Trincal

New York, June 29 – Toronto-Dominion Bank’s $12.81 million of 0% leveraged notes due June 26, 2025 linked to the Euro Stoxx 50 index offer uncapped enhanced return over a short tenor, terms that may not be easily replicated with a U.S. index. But those advantages need to be weighed against the loss of a hefty dividend yield and the risk associated with a toppish market, sources said.

If the final level is greater than the initial level, the payout at maturity will be par plus 1.51 times the gain, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes flat or declines up to 25%, the payout at maturity will be par. Otherwise, investors will lose 1% for every 1% of index decline from its initial level.

The notes are not callable.

Bullish case

Steven Foldes, wealth manager and founder at Evensky & Katz / Foldes Financial Wealth Management, said the structure was designed for European bulls.

“This has leverage and no cap. It would be for someone who is very bullish,” he said.

Foldes said he was himself bullish on the asset class.

“It’s expected that within the next two years we should have a resolution to the Ukraine war. That would be very positive for European stocks,” he said.

“Also, Europe is much cheaper than us. They have been lagging the U.S. markets for half a dozen years. Europe is due. In fact, it is beginning to come into its own.”

Based on his optimistic outlook, this adviser was satisfied with the downside protection.

“The 25% barrier given some potential headwinds is a good idea,” he said.

Dividend vs. growth

Investors considering the notes should be bullish for an additional reason.

“You need this index to go up quite a bit because you’re giving up a substantial amount of dividends, almost 6.5% for the period,” he said.

The Euro Stoxx 50 index has a dividend yield of 3.22%.

“With the 1.5x leverage, you can make it up, but you need growth.”

In order to break even, the price index would have to rise at least 12% over the two-year term in order to offset the “loss” of dividends.

Investors considering the notes would have to decide whether giving up the high dividend yield made sense based on their own market outlook. For Foldes, the answer was: yes.

“Given that you have uncapped leverage on the upside, losing substantial dividends is an acceptable tradeoff to me. Yes, you lose 6.5%, but it’s expected that you will make that up and more,” he said.

Strong rally

Dasale Arachi, head of U.K. distribution at Hilbert Investment Solutions in London, had a less bullish outlook. He questioned the value of uncapping the upside based on the index’s current levels.

“The issuer has a good credit and I like the two-year term. This is fine. It’s a good product, but is it the right time for this product?” he said.

“The Euro Stoxx is a little bit high at this time. How much more growth can you expect really?

“The leverage with no cap is great. But if I had to make a tweak to the structure, maybe I would put a cap on it and increase the leverage. With the index already up, I think it would be a better option.”

On the downside, the 75% barrier could have been lower, he said.

The index closed at 4,271.61 on the trade date, setting the barrier level at 3,203.7075.

“This level was last seen towards the end of September, which is not too long ago,” he noted.

Since that point, the Euro Stoxx 50 index has gained more than 30%.

“From my perspective, the index is extremely high. If you want an uncapped note like this one, you must have a strongly bullish view. I’m not sure it’s the right time to make that bet. I don’t think we’re under the best circumstances,” he said.

“It would make more sense to me to introduce a cap and increase the participation rate.”

In doing so, investors could magnify even a small index gain, he said.

Downside

Uncapping the upside may also allow for an improved downside protection but there may not be enough room to price more leverage and a lower barrier together at the same time, he said.

“I don’t know how much you have to play with. But, yes, we would definitely prefer a deeper barrier than this,” he said.

He pointed to some of the risks weighing on European markets, such as Central Bank’s hawkishness in response to inflation as well as recession. The Bank of England raised interest rates last week, and the European Central Bank did the same the week before, he noted.

Simultaneous interest rate hikes in the United States, the euro zone and the United Kingdom could put additional pressure on the economy and the global markets, he added.

“That could be a concern,” he said.

In conclusion, Arachi said that leverage in general may not be the best way to generate high returns when applied to underlying assets that have already reached high valuations.

In the case of the Euro Stoxx 50 index, having no cap may not be all that helpful, he said.

TD Securities (USA) LLC is the agent.

The notes settled on Wednesday.

The Cusip number is 89114YZW4.

The fee is 1.5%.

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