Scotia’s autocallable market-linked step-up notes on the S&P 500 fit sideways scenario

By Emma Trincal

New York, Oct. 20 – Bank of Nova Scotia’s 0% autocallable market-linked step-up notes due October 2028 linked to the S&P 500 index may benefit investors if the index moves in a range or finish with a lackluster performance at maturity, advisers said.

The notes will be called at par plus an annualized call premium of 8.5% to 9.5% per annum if the index closes at or above its initial level on any annual observation date, according to an FWP filing with the Securities and Exchange Commission. The exact call premium will be set at pricing.

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

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

If the index declines no more than 15%, the payout at maturity will be par. Otherwise, investors will lose 1% for every 1% decline of the index below 15%.

Too long

“Six-year note? Talk to you later! I don’t like to be locked in for six years. Of course, you could get called any of those years, but then, your return is capped at 9%,” said Steve Doucette, financial adviser at Proctor Financial, using a hypothetical call premium set at mid-range.

Cutting corners

The adviser pointed to a discrepancy between the step payment and the sum of the call premium at the end of the sixth year.

“If it’s 9% a year, they should give you 54% at maturity, not 50%,” he said.

The step payment when using the range, not the midpoint, should be between 51% and 57%, he added.

“It’s like a digital in a way. It’s just weird that they would give you less of a premium at maturity,” he said.

“But I do like the uncapped upside if the index is above that 50% level. That’s not how you’d outperform. But it’s nice not to be capped out after six years.”

Fear of missing out

The notes were really designed for investors holding a rangebound view on the market, he said.

“You’ll only outperform if the market is up between 0% and 50% in six years.”

He said he doubted it would be the case.

“The market is down, and it will come back. Chances are it will come screaming back up because that’s what happens after a bear market. So, chances are you’ll be giving up all that upside. You lost the opportunity to participate in a strong rebound,” he said.

Bearish setup

The benefit of the notes depended on the timing and the strength of what Doucette foresaw as a predictable market recovery.

He ran a bearish scenario first, which did not really match his expectations.

“If we have a couple of ugly years ahead of us, then theoretically, you may end up flat in six years because the more the index drops, the more you need it to go up just to break even, so it may take time.

“In that case, as long as you end up flat or even slightly up at maturity, you’re going to outperform,” he said.

But Doucette was not convinced such a scenario would play out.

Upside ahead

“We’re already down 25% and we’ve seen how quickly the market can turn around,” he said.

That’s why getting called over the next few years with a 9% annual return appeared more likely, he said.

“You get called. You miss the upside. That’s the problem,” he said.

Doucette also objected to the buffer.

“I don’t understand why the buffer is here, quite frankly. It’s not going to benefit you. After six years, chances are you won’t be negative and that’s if you haven’t been called before,” he said.

“You have the potential to outperform with this note. I just think it’s a pretty slim window.”

Tenor, return

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said the notes met his market outlook.

“It’s an interesting product. I like the tenor as a long-term hold with downside protection,” he said.

“I’m not familiar with Scotia Bank. There’s no reason to think there is an issue. But I would need to check the creditworthiness of this issuer just because six years is a long time to be exposed to credit risk.”

The 9% return was in line with the historical average of the S&P, he added.

“I’m not concerned about the 9% cap if I get called because I don’t anticipate an asymmetrical rebound. In other words, I don’t expect a 40% drawdown followed by a big turnaround like during the mortgage crisis,” he said.

Slow improvement

For Medeiros, a recovery would probably be gradual.

“The uncertainty will be in the next couple of years. The market could trend either way, up or down,” he said.

“Because there is an equal argument on both directions of the S&P for the next couple of years, in my mind, that’s why you would buy this kind of note.”

Determining whether or when the notes may be called was difficult if not impossible, he said.

“There is no clear direction,” he said.

But overall Medeiros said he was comfortable with both the early redemption scenario and the long-term holding of the notes to maturity.

“Either way, I get a 9% annualized return, which is reasonable in my opinion.

“I think it’s a good note,” he said.

BofA Securities, Inc. is the agent.

The notes will price in October and settle in November.

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