UBS’ worst-of autocall tied to two stocks offer high headline yield, but losses can be high

By Emma Trincal

New York, Nov. 17 – UBS AG, London Branch’s 0% trigger autocallable contingent yield notes due Dec. 2, 2020 linked to the common stocks of Bank of America Corp. and JPMorgan Chase & Co. offer a balance between the risk associated with a worst-of and the relatively high correlation between the two underlying stocks, said Tim Mortimer, managing director a Future Value Consultants.

As with most autocallable products, investors are very likely to see the notes redeemed early. But if it does not happen, the amount of losses can be significant, he said.

The notes will pay a contingent quarterly coupon at an annual rate of 8.5% to 9.5% if each index closes at or above its 70% coupon barrier on the observation date for that quarter, according to a 424B2 filing with the Securities and Exchange Commission. The exact coupon rate will be set at pricing.

After six months, the notes will be called at par plus the coupon if each index closes at or above its initial level on any quarterly observation date after six months.

The payout at maturity will be par unless either index finishes below the 70% downside threshold, in which case investors will lose 1% for every 1% decline of the worse performing stock.

Future Value Consultants generate stress testing reports for structured notes. For this note, the report used a hypothetical contingent coupon of 9%, or 2.25% per quarter, at midpoint of the range.

Correlation

Unlike income products such as traditional reverse convertibles, the worst-of use the correlation risk as a way to generate more yield, Mortimer explained.

One mitigating factor with the correlation risk introduced in this product however is the fact that both underlying stocks are in the same sector. Their coefficient of correlation is 0.84.

“Both are bank stocks. Their correlation is high. When that’s the case, your risk is lower because it’s less likely that one stock will move in the opposite direction of the other,” he said.

The worst-of will still provide slightly more yield than a similar autocall product which would be linked to a single asset, he said. Part of the risk is that the call is not as easily triggered with two assets than with one.

“It’s a little bit more risk but the yield is slightly better. So that’s what people do,” he said.

The note offers a “9% headline rate, which is quite high,” he added.

The barrier is measured against the worst performing of the two stocks.

“As long as both stocks don’t fall below 30% you can expect to have your coupon.”

While the product structure allows investors to receive a coupon without being called for some time, the likelihood of such scenario, in particular of collecting the coupon for more than a year, is very small.

The report provides some more details.

Early call

One of the tests in the report, named investor scorecard, shows various outcomes with their respective probabilities of occurrence. This product has 11 call dates, each of which are a unique outcome. The two other outcomes are maturity scenarios: investors at the end may lose money or they may not.

“This product, like any other autocall, gives you a very high chance of calling on the first call date,” he said.

After the six-month no-call period, investors have a 42.50% probability of getting called on the first call point, according to the scorecard.

“This probability falls quite rapidly as you move along,” he added.

There is only 9.5% chance of a call on the ninth month, which is the second call date. The probability drops to 5.10% on the first-year anniversary of the notes.

Maturity

When the notes mature, there is only an 8.29% chance of not losing money while the odds of losing are more than twice as great with a 20% probability.

In a neutral scenario – the base case pricing used for the simulation – investors incurring losses can expect to lose in average 41% of principal.

“That’s a substantial amount of losses, it’s more than the barrier amount of 30%,” he said.

Back testing

Future Value Consultants, in addition to the Monte Carlo simulation, provides back-tested analysis.

With the strong bull market, the probabilities of a call on the first observation date rise to 51% in the past five years from 42.5% in the simulation. By the same token, the chances of losses fall below 5% versus 20% in the Monte Carlo projection.

Losses in the last five-year back-testing are also much more limited in size – 25% in average – compared to the 41% average for the simulated results.

A look at the past 10-year table shows less attractive results than the most recent period: a 26.5% probability of losses averaging 57.4%.

“That would be because we go back to some of the years across the financial crisis,” he said.

“It was a banking crisis. The shock was concentrated in this sector and you have two bank stocks here. That increases the probabilities of losses as well as their size.”

Risk assessment

In conclusion, the notes offered the typical profile of an autocall with its specific risk-adjusted reward.

“It has the six-month no-call, which is good for investors. You know you will at least earn 4.5%, which is better than being called after three months with 2.25%,” he said.

“Otherwise, it’s still pretty standard. You have a pretty high coupon. You’re likely to get called soon, within the first year. But there are risks. It’s about weighing the chances of losing money.”

That chance to lose is one out of five with an average loss of 40%.

“This is why it’s a good thing to get called. It is the positive outcome, and with these products, it’s also the most probable.”

UBS Securities LLC and UBS Investment Bank are the bookrunners.

The notes will price on Nov. 27 and settle on Nov. 30.

The Cusip number is 90270KPB9.

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