BMO’s 9.7% autocall notes on VanEck Vectors Gold made to work with American barrier

By Emma Trincal

New York, Aug. 30 – The combination of a volatile underlying and a particular style of barrier allowed Bank of Montreal to price notes paying a fixed, high-yielding coupon over a short tenor, sources said.

Bank of Montreal’s 9.7% autocallable cash-settled notes due Oct. 5, 2018 linked to the VanEck Vectors Gold Miners exchange-traded fund will pay interest monthly, according to an FWP filing with the Securities and Exchange Commission.

The notes will be called at par plus the coupon if the fund closes above the initial level on any monthly call date beginning March 5, 2018.

The payout at maturity will be par plus the coupon due unless the fund finishes below its initial level and closes below the 70% trigger level during the life of the notes, in which case investors will lose 1% for each 1% decline.

Guaranteed payments

The notes offer a fixed interest rate, a feature that has been much less visible in today’s structured products market compared to a few years ago due to low volatility levels, according to data compiled by Prospect News.

The coupon size approaching double-digit level is compelling, said a market participant. Finally the product’s maturity is only 13 months, which is short for a fixed rate and at this level, he noted.

Perhaps the most unusual feature in the structure was the so-called American barrier. This term designates a barrier, which can be hit on any day as opposed to the more common European barrier observed at maturity.

Finally the six-month “no call” gave investors a call protection for nearly half of the term, he noted.

Gold

“When you structure a note you start with a theme. Gold right now is very topical. It has reached new recent highs due to the geopolitical tension with North Korea,” he said.

“You can hear it on CNBC....think about gold if there’s a war with North Korea.”

The second step was to look for a particular coupon.

“How attractive does the coupon have to be? Here they wanted something close to 10%. It’s pretty compelling,” he said.

Tenor

The tenor is part of the puzzle.

“Usually getting more than one year is important for retail investors because they don’t want to have to pay taxes on short-term capital gains,” he said.

In this case however, the notes bear a fixed rate, which could very well translate into ordinary income tax treatment, according to the prospectus.

“Then I guess the point is moot.”

Downside protection

“Next you look for the right barrier,” he said.

Even if investors are bullish on the gold miners fund they still need some protection.

“If you had a European style barrier of 70% the pricing wouldn’t work,” he added.

“They couldn’t pay you this yield on a one-year especially on a coupon that has no barrier. And you also have this six-month no call, which guarantees you half of the coupon. That’s another attractive thing. Something’s got to give.

“They made it an American protection. That’s how the pricing could work. That’s what they went for.”

Volatility

An industry source also noted the role of the American barrier, saying that it was the item allowing the issuer to combine all those terms.

“The 9.7% coupon is high already. If it was a contingent coupon it would be a lot more,” this source said.

A highly volatile underlying could contribute to a higher yield, which may have played out in this structure.

The VanEck Vectors Gold Miners ETF shows an implied volatility of 26% versus less than 10% for the S&P 500 index.

In comparison, a gold miner stock such as Freeport-McMoRan Inc. has an implied volatility of 35%. But many other underlying single-stocks recently used in other products such as Facebook Inc., Apple Inc. and Bank of America Corp. have lower volatility than the gold miner fund, some of which less than 20%.

“It’s because of the American barrier that they were able to get this yield,” he said.

A matter of choice

Fixed rates are not necessarily uncommon, this industry source noted.

“Sometimes I have clients who want a fixed coupon. It’s a matter of preference. This deal is probably a one-off,” he said.

“When it comes to indices, it becomes contingent.

“You can structure a fixed rate if there’s enough volatility, preferably with a single-stock or fund like this one.”

Otherwise on an index the coupon has to be determined based on a coupon barrier.

BMO Capital Markets Corp. is the agent.

The notes (Cusip: 06367TD23) will settle on Sept. 5.

© 2015 Prospect News.
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