BNP Paribas' callable Certi+ 200 notes linked to S&P 500 offer uncapped upside, protection

By Emma Trincal

New York, Dec. 7 - BNP Paribas' 0% callable Certi+ 200 notes due June 30, 2014 linked to the S&P 500 index offer the unusual feature of providing upside leverage and partial downside protection with no cap, said a market participant.

"I would say it's pretty unique, especially in equities," he said.

"Everything we know, all buffered leveraged notes are always capped."

If the final index level is less than the knock-out level, investors will be fully exposed to the decline of the index. Otherwise, the payout at maturity will be par plus 200% of the index return, subject to a minimum payout of par, according to a term sheet.

The knock-out level is expected to be 70% of the initial index level.

The notes are redeemable at 114% to 117% of par on March 28, 2013.

The exact knock-out level and early redemption amount will be set at pricing.

Call or maturity

The market participant described the various scenarios for investors based on two potential outcomes: a call occurs half-way through the term or the notes mature.

"Say the notes get called after 15 months. The investor gets a 14% premium. Chances are he's happy, especially if the index finishes up by less than the premium at the end of the term," he said.

"If he gets called at 14% and the index ends the two and a half years at 20%, it's not as great. But generally clients don't really complain because the call premium is a positive experience for them. They get their money back sooner.

"If the index is up on the call date, the issuer is likely to call regardless of the increase, even if the index is up 5%, because it's cheaper for the issuer to fund the deal."

The second possible outcome is the absence of an early redemption, with the final index level being compared to its initial value to determine the payout.

"If the index is down 35%, the investor loses 35%. He's not happy, but he realizes that he would have lost the same if he had invested in the index directly. It's not the product that hasn't performed. It's the market," he said.

"Second possibility: The market is down by less than 30%, the investor gets his money back. And if the index is up at maturity, great, the investor gets two times the upside."

This market participant said that investors in the notes hope that the S&P 500 will not be higher than its initial level on the call date, so that they get an "opportunity" for a "substantial uncapped upside."

If the notes get called, however, investors will pocket a "substantial premium" of at least 14%, he said.

"Investors in these notes see the market trading sideways. They don't make the decision to call. It's at the discretion of the issuer. But they get a high premium for that," he said.

Automatic versus regular call

A structurer said that uncapped notes with upside leverage and barriers are not uncommon.

"We've done similar structures, leverage with a barrier around the same maturity without a cap, only it was an autocallable. I kind of like it better. It's easier for the client to understand," the structurer said.

"Instead of leaving it to the discretion of the issuer, people understand why they called it or why they didn't. There's no ambiguity.

"However, the ambiguity translates into more risk, and more risk commends a higher premium."

The market participant was not convinced that investors prefer autocallable structures to a straight call feature at the discretion of the issuer.

"We've tried both versions, the autocall and the regular call. Believe it or not, clients prefer it when it's not autocallable," he said.

"There's a little bit of an element of surprise when the issuer has the right to call.

"But clients understand what it means because historically, that's the way most deals have been structured until autocallables came around a couple of years ago.

"Besides, you get slightly better terms."

Structuring challenges

The structurer said that upside leverage with no cap is more common with other asset classes than equities, in particular with currencies, due to option pricing factors.

"But in general, a leverage uncapped is a little bit difficult to do," he said.

"You'd have to have the right term on the notes, and two and a half [years] is relatively short. For a two and a half, I would expect to get a cap for that type of upside, especially with a 70% contingent barrier on the downside.

"You could explain these interesting terms if their funding levels got higher. But it's probably not the case. BNP's CDS spreads have come way back in the past two weeks."

Two weeks ago, the credit default swap spreads for BNP Paribas were 360 basis points. As of Tuesday, the spread was more than 100 bps tighter at 250 bps, according to the structurer.

"You can't really explain it from the standpoint of funding. When they announced it, their spreads had already tightened a lot."

The term sheet was dated Dec. 5.

"Besides, some U.S. banks like Morgan Stanley or Goldman Sachs have wider spreads," he added.

Morgan Stanley and Goldman Sachs are showing CDS spreads of 390 bps and 300 bps, respectively.

"The call feature must be their protection," this structurer continued.

"If the index is up, there's a high likelihood that they'll call.

"Perhaps the two-times upside with no cap is a little bit of a teaser because they'd call it."

The market participant agreed that the upside may be limited to the call premium.

"There is no free lunch," and investors do take the risk of seeing their notes called after 15 months with a 14% premium. "But it's hard to complain about it."

On the other hand, if the notes are not called, investors have a fair shot at capturing an attractive upside because 15 more months still have to elapse prior to maturity, explained the market participant.

"No one is saying that the two-times upside is a done deal, but there is a real potential simply because there's so much time. In those last 15 months, the index could be down and then rally significantly," he said.

The notes (Cusip: 05567L3S4) are expected to price Dec. 22 and settle Dec. 28.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.