TD Bank’s capped leveraged buffered notes tied to EAFE ETF offer credit diversification

By Emma Trincal

New York, May 31 – Toronto-Dominion Bank’s 0% capped leveraged buffered notes due June 3, 2021 linked to the iShares MSCI EAFE ETF offer “reasonable” terms, but investors’ main rationale behind buying the notes might simply be the creditworthiness of the issuer, sources said.

If the ETF return is positive, the payout at maturity will be par plus 200% of the ETF gain, capped at par plus 10.2% to 11.2%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the ETF declines by 10% or less and will lose 1% for every 1% that the ETF declines beyond 10%.

Cap

Tom Balcom, founder of 1650 Wealth Management, said the deal was “fair.”

“A 10% cap with a 10% buffer for a two-year, this appears reasonable, even favorable,” he said.

He was referring to the annualized compounded maximum return, which will be comprised between 9.73% and 10.63% depending on where the final cap level is set.

Such maximum return can be achieved when the index is up between 5% to 5.45% a year.

Buffer

“If you want EAFE exposure this is a good note for you. The terms are fair for this note,” he added.

The 10% buffer for a two-year term was seen as “fair” as well.

“The notes will mature six months after the U.S. Elections, which should reduce the volatility worldwide. However, European-specific risks remain, especially the future outcome of Brexit. This is still something investors need to take into account.”

Sluggish performance

The performance of the underlying ETF has been lackluster with a 5.6% annualized return over the past 10 years versus 10.55% for the S&P 500 index, according to Morningstar. If the lagging trend continued, investors in the notes would have an advantage over shareholders, he said.

“The two-times leverage allows you to outperform if growth is subdued. If the index beats the cap, at least you can explain to your clients that it’s the necessary tradeoff for the downside protection. Most of the time, they understand. If they didn’t, they wouldn’t invest in structured products.

“On the downside, you will outperform because it’s a buffer, not a barrier. Even if you take into account the unpaid dividends, you’re likely to be ahead.”

Canadian banks

Another benefit offered by the note was the name of the issuer.

“TD is a good credit diversifier in a portfolio. You don’t see the name all too often,” he said.

“This is probably one of the most favorable aspects of this note.

“Canadian banks have good credit ratings in general. Our clients welcome Canadian issuers. We do have quite a few in our portfolio such as National Bank of Canada, Scotia and TD Bank.”

Not about the structure

A market participant said that the structure was not the most attractive aspect of the offering compared to the creditworthiness of the issuer.

“The deal itself is pretty much in line with what we’re seeing. In fact, we’ve seen better recently,” he said.

“We came across a JPMorgan, two-year, 2x on the upside and a 10% buffer, just like this one and also tied to the EAFE. But the cap was much higher. It was 19%.

“People buy Canadian banks for the name.

“For investors really sensitive to credit risk exposure, it’s typically better credit. The exposure is different from American banks even though it’s still banks.

“When you see Canadian banks it’s almost always related to credit concerns. Their pricing is not as compelling because of the credit. Their [credit default swap] spreads are a lot tighter than a lot of American banks.

“This deal is more about credit diversification than the terms.”

TD Securities (USA) LLC is the agent.

The notes will settle on June 5.

The Cusip number is 89114QQ84.

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