Bank of the West's CDs tied to stock basket introduce simplicity, lock-in-interest feature

By Emma Trincal

New York, April 6 - Bank of the West's upcoming growth opportunity market-linked certificates of deposit due April 30, 2018 linked to a basket of stocks are designed for investors who want to participate in the upside of the equity market with an opportunity to lock-in gains along the way, said a market participant, adding that the lock-in feature introduced in the product was an innovation he had not seen before in a CD.

"This new product offers a growth opportunity, more simplicity and a new feature that locks in returns," he said.

The basket includes the common shares of Altria Group, Inc., AT&T Inc., Bristol-Myers Squibb Co., Dominion Resources Inc., Kimberly-Clark Corp., Southern Co. and Verizon Communications Inc., according to a term sheet.

Interest is payable at maturity and will be the greater of the basket performance and the lock-in interest.

If on any annual lock-in observation date, the basket return is greater than or equal to 35%, the lock-in interest will equal 35%. Otherwise, it will be 0%.

The maximum return to be set at pricing will be between 65% and 75%.

At maturity, holders will receive the deposit amount less any fees plus any interest that may be due.

"The CD is designed for investors looking for protection and seeking a long-term exposure to equities," the market participant said.

"They want to get an upside participation computed the most simple way, which is point to point, from start to finish.

"Those investors also want the additional comfort of locking in a minimum payout should the market rally. And that's how this structure innovates with the 35% lock-in feature."

Simplicity

The market participant said that the most simple payout structure for a growth market-linked CD is point to point, which, he said, is not the most seen in the market.

Rather, most equity-linked CDs offer payouts that are based on the complex averaging of annual or quarterly performances, he noted.

"We call the point to point structure a call spread because those products often have a cap; otherwise issuers couldn't price them," he said.

"Compared to other structures, the point to point is the simplest one and the easiest one to explain to a client."

Staci Goins, equity derivatives analyst at BB&T Capital Markets, said the new product fills a void.

"It's a true point to point with a basket of equities and we haven't seen that in a number of years," she said.

Capturing the upside

The opportunity for investors to lock-in a fixed return on any anniversary date is what differentiates the product the most from other market-linked CDs, the market participant said.

"To my knowledge, this feature has never been offered in a CD before," he said.

"If on any anniversary the basket is up by 35% or more, the payout at maturity is floored at 35%," he explained.

"So for example, if the basket is up by 37% after three years and consequently declines, investors are still guaranteed to receive 35% payout at maturity.

"If on the other hand the basket is up by 37% after 3 years and consequently increases, investors fully participate in the upside, up to the 65% to 75% cap."

The lock-in was introduced as a way to address one of the drawbacks of point-to-point payouts, said Goins.

"One argument against point-to-point structures was that you could have a huge run up in the market followed by a sell-off, in which case the client was potentially left with nothing. The lock-in mechanism addresses that issue, and as a result, it resonates well with investors."

In order to offer the lock-in feature, the issuer had to cap the structure, the market participant said.

"But the cap is about 10% a year. That's very much in line with the historical performance of the equity market," he said.

Blue chip stocks

The underlying basket consists of a basket of U.S. blue chip stocks.

"The basket was designed to limit correlation between the stocks. Clients don't like excessive concentration," the market participant said.

"Some of those stocks pay significant dividends," said Tony Romero, managing partner at Suncoast Capital Group.

"AT&T for instance pays 5.5%. So just by owning the stock for seven years, you can earn 38%. I think that with this CD, you're sacrificing your dividend just to get the FDIC insurance," Romero said.

"Seven years is a pretty long time to own a security. Granted you have full principal protection. But the market could be up more than 75% for the next seven years. Personally, I would prefer to own the equity myself," he said.

Romero however said that more conservative investors may feel differently.

"If you've been beat up in the market so badly and don't want to risk any of your principal, and if you like the idea of participating in a market upswing, I can see why you would find it interesting. At the same time, the dividend gains you're giving up are fairly significant."

Trade-off

The market participant said that no security offers all benefits combined into one product.

"It's a trade off like anything else in life," he said.

"You're giving up dividends and you're giving up returns in excess of the cap. But you're getting principal protection with FDIC insurance plus the opportunity to lock in a high return if the market declines."

The CDs (Cusip: 06426XAV2) are expected to price on April 26 and settle April 29.

BNP Paribas Securities Corp. is the agent.

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