BNP Paribas' certi plus notes linked to S&P, Russell combine autocall, upside participation

By Emma Trincal

New York, Jan. 10 - BNP Paribas, NY Branch's upcoming 0% autocallable certi plus notes due Dec. 28, 2015 linked to the worst of the Russell 2000 index and the S&P 500 index offer a noteworthy payout, sources said, by combining an autocallable feature with upside leveraged participation in the event the notes do not get called.

If each index closes above its initial level on July 28, 2014, the notes will be called at a 14% to 16% premium, according to a term sheet.

If the worst-performing index finishes above the 60% barrier level, the payout at maturity will be par plus double any gain of the worst-performing index, with a minimum payout of par.

Otherwise, the payout will be par plus the return of the worst-performing index with exposure to losses.

The exact terms will be set at pricing.

"It's an autocallable with an interesting feature that gives you two times the return if the indexes close up. I haven't seen it. It's an interesting component," said Steve Doucette, financial adviser at Proctor Financial.

For Matt Medeiros, president and chief executive of the Institute for Wealth Management, the appealing feature was the amount of downside protection even if the payout is based on the "worst-of" structure.

"This is an interesting idea. I like the fact that it's such a large buffer. I don't see this 40% level being breached on a three-year timeframe even if you look at the 'either or,' I mean, even if you only consider the worst index," Medeiros said.

Call or leverage

For investors, the payout can be summarized in two possible scenarios, explained Doucette.

In the first one, the notes get called in 18 months, which would give investors an annualized return of 9.5% to 10.5%. In the second one, the notes do not get called and if both indexes finish up, investors would get twice the performance of the worst of the two.

Doucette said he liked the call scenario except for the upside risk, or the risk of missing out on the greater returns a long position would provide.

"It's a coupon on the way up. The only time you lose is if the market is up more than the coupon and you get called out at 14% or 16% after 18 months. But who is going to complain with a 9% to 10% annual return?" he said.

"Your principal is protected all the way down on the 60%.Then, you're just long the worst index."

The worst-of feature - or a payout based on the worst performance of two or several underliers - was not necessarily a bad thing, he noted.

"By combining the two underlyings, they're able to spread out the ranges. If it was on one index only, you wouldn't get that type of return," he said.

But perhaps the most attractive aspect of the structure, he added, was the flexibility of owning an autocallable product with possible upside participation if the notes are not called. In addition, the upside in this product is leveraged by a factor of two.

Bond replacement

"I like the fact that it can be both an autocallable and a leveraged note," Doucette said.

"We look at these autocallables as bonds replacement products. This one leans towards an equity allocation, but it tries to minimize the risk. It's a reasonable bond substitute. Remember, these notes don't get hit in a rising interest rate market. That's why we look at these autocallables as bond substitutes because we do expect interest rates to rise," he said.

But the product is not limited to that.

"If the notes do not get called, investors get the market participation," he said.

Doucette compared this non-call scenario with the return an investor would receive from an hypothetical "standard" autocallable of the same duration. He assumed that the autocallable would earn the 10% contingent coupon for three years until maturity, or a 30% return.

"What happens in this scenario? Can this note outperform the autocallable?" he said.

"Well, first, you'd have to assume that your note doesn't get called after 18 months. Based on that, yes you can easily outperform the autocallable. After 18 months, the market only has to rise by more than 15% for the next 18 months for you to outperform."

Doucette said that with this note, as with any other structured note, the important thing was to "look at how it is positioned" in the portfolio.

"I like it as a bond substitute, but I don't like it as equity," he said.

"If the market is up after 18 months, you don't want to be called out just for the coupon.

"But this is an interesting product. Issuers are starting to be more creative."

Bet on the S&P

For Medeiros, the performance gap between the two equity benchmarks was important to anticipate. His own market view leads him to bet on the S&P 500 rather than on the Russell 2000 as the worst performer.

"We're seeing a switch in the market from the large caps towards mid and small cap. We anticipate the Russell 2000 to outperform the S&P over the next three years," he said.

"That's where the bigger question is: how much will the S&P lag the Russell?

"Would two-times the S&P be greater than the Russell? Will twice the performance of the lagger be better than the best performer? It's not possible to know. We're talking variability or delta. But obviously, that's the bet," he said.

Despite a performance linked to the worst of the two indexes, Medeiros said that the downside protection made him confident about the investment.

"What I find attractive is that there's still potential volatility in the asset class, in either one index or the other. And at the same time you get an attractive buffer for either asset class," he said.

"I believe that the return of the worst performer times two will be attractive over a three-year period."

The potential early exit if the notes are called may be a good thing for investors, he said.

"Frankly, if it gets called away, you get a nice return in half the length of time. It appears that you'd be better off getting called and buy the ETF anyway," he said.

Medeiros said that he liked the basic premise of the product, which gives investors two types of payouts.

"I really like the concept of this note. You can get called away and still get a decent reward for holding the security," he said.

The risk, which is based on the worst-of payout and the potential market volatility looking forward, was well balanced by the potential upside, in his view, or at least investors received adequate compensation for the risk they were taking, he said.

"I don't see investors looking to be greedy right now," he said.

"A nice return for taking risk is what they're looking for. And I think this is what they get here.

"Investors have to take some risk, but it's encouraging to do so when you know that you have a decent downside protection. To me the 40% cushion is reasonable. I just don't see the market being down 40% three years from now."

BNP Securities is the agent. The distributor is Advisors Asset Management, Inc.

The notes will price on Jan. 28 and settle on Jan. 31.

The Cusip number is 05574LED6.

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