Sources analyze step-up payout in TD Bank’s $104.08 million autocalls on S&P 500

By Emma Trincal

New York, Oct. 5 – Toronto-Dominion Bank’s $104.08 million of 0% autocallable market-linked step-up notes due Sept. 29, 2028 linked to the S&P 500 index was this year’s top deal in this structure type in terms of size, according to data compiled by Prospect News. But rather than the size, sources paid attention to the payout structure.

The notes will be called at par of $10 plus a premium of 10.9% per year if the index closes at or above its initial level on any annual observation date, according to a 424B2 filing with the Securities and Exchange Commission.

If the index finishes above the step-up level, 150% of the initial level, the payout at maturity will be par plus the index return.

If the index finishes flat or gains up to the step-up level, the payout will be par plus the step-up payment of 50%.

If the index declines but finishes at or above 85% of its initial level, the payout will be par. Otherwise, investors will lose 1% for every 1% that the index declines beyond 15%.

Higher call return

Sources noted that the step-up payment was only 50%, a level inferior to the cumulative amount of call premium, which over six years should be 65.4%. Data compiled by Prospect News showed that past autocallable market-linked step-up notes used to offer a step payment equal to the sum of all the call premium. But over the past couple of years, step payments have decreased below that threshold.

“At least there is the possibility of collecting those premium year after year,” an industry source said.

“I hate when you get to maturity and receive nothing but your principal back if you haven’t been called. Here you can either outperform the market or fully participate.”

The “lower” step-up payments offered some compensation, he added.

“Do you want downside protection at maturity? You get it. You have a 15% buffer,” he said.

“So, while you’re only getting a 50% digital at maturity and not 64%, you have a pretty good amount of downside protection.”

Premium first

Whether investors accept the “lower” step-up payment depends on their market outlook, he said.

“Very few investors buying those kinds of notes – and remember, it’s a six-year note – very few actually believe that the note is going to hold until maturity,” he said.

“You have to think the market is not going to be up much over the next six years. This is for a sideways view just like an autocall except that if the notes mature and the index is up, at least you can see some upside at maturity.”

But investors are not buying the notes for the upside and not even for the step-up payment, he said.

“What they’re looking for is a high premium.”

This source said the deal was “huge” but that he was not surprised by its size.

“It comes from the BofA platform. They’re aggregating orders. It’s not a single adviser. It’s a network and it’s a big network. So, to me it’s not earth-shattering. Show me a single stock deal over $100 million and you would get my full attention,” he said.

The rationale

A market participant offered his own view on the 50% step-up payment.

“Yes, you could say that they short-change you a little bit. Most people by the way don’t even pay attention,” he said.

But he justified the pricing in two ways.

“First, investors buy those notes because they expect to be called at some point, so it doesn’t really matter to them if the step is 50% or 65%.

“Second, you’re still going to outperform if you’re anywhere between 100% and 150% at maturity.

“Finally, by lowering the step, you get a higher coupon or perhaps a bigger buffer or even a little bit of both. As always, it’s a tradeoff,” he said.

3D printing

He explained that structured notes pricing in general is a “trial and error” process.

“It starts with advisers asking to see a deal. They’re shown a 9% call premium and a 154% step. They say: ‘nah... I want a double-digit coupon.’ The salesperson goes to the issuer, comes back and shows them another combination: a six-year with an 11% coupon but a lower step. It’s not like they give advisers a choice. The computer does everything, and the process is just a back-and-forth between the adviser and the salesperson. They come back to you with a different combination. It’s a package. There’s no other way. Too many variables.

“Gone are the times when you structured a note like a jigsaw puzzle, piece by piece, sitting at your desk with a spreadsheet. Your pricing today is like a 3D print. They put on some criteria, run the model. It’s all blended. Even they don’t know how it’s done either,” he said.

BofA Securities, Inc. is the underwriter.

The notes will settle on Thursday.

The Cusip number is 891162364.

The fee is 2%.

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