Three-month no-call period on CIBC’s $11.46 million 9.83% notes on S&P 500 seen as too short

By Emma Trincal

New York, March 27 – Canadian Imperial Bank of Commerce’s $11.46 million of 9.83% trigger callable yield notes due June 27, 2024 linked to the S&P 500 index offer attractive terms but the unpredictability of the issuer call and the short call protection period were deterrents for advisers.

Interest is payable monthly, according to a 424B2 filing with the Securities and Exchange Commission.

The notes are callable at par of $10 on any monthly coupon payment date after three months.

The payout at maturity will be par unless the index finishes below its 65% downside threshold level, in which case investors will be fully exposed to the index’s decline.

Banking jitters

“I would pass,” said Carl Kunhardt, wealth adviser at Quest Capital Management.

“I would pass even though it’s a very tempting note. One of the tempting things is that you’re guaranteed to earn 2.5% in three months. That’s a no-brainer.”

He was referring to the first three-month worth of coupon payment during which the notes will not be called.

“I also like the fact that it’s on the S&P. Not a worst-of. And also, it’s short-term.

“However, I’m not really keen on banks right now. In this case your 2.5% earned in three months really depends on the health of CIBC,” he said.

Over the past three weeks, the global banking system has generated volatility and worries. Two U.S. regional banks collapsed early this month, while Swiss regulators organized the merger between Credit Suisse and UBS. On Friday, Deutsche Bank scared the market after its credit default swaps jumped.

Too uncertain

But the short three-month call protection was his main objection to the investment.

“They can call the notes in June. That means I can’t count on anything after three months. In general, I buy notes because of their stability. I want to be able to run a decision-tree and have some expectations. But since the call is at the discretion of the issuer, I really have no visibility,” he said.

“The 65% barrier is great. But what’s the use if I’m called?”

In addition, the uncertain duration made it difficult for an adviser to allocate the notes to the right place.

“It’s hard to know where it fits in the portfolio. To the extent that it’s tied to the S&P, the allocation is easy. It goes to your large-cap U.S. equity bucket. But it’s more of a fixed-income note. Your return doesn’t depend on the index. Only your principal at maturity depends on the index. It’s not a pure equity play because of the income. And it’s not a bond since your principal is at risk,” he said.

“I really wouldn’t have any use for it.”

The callability is more predictable than it appears, said a portfolio manager familiar with those issuer call notes. Yet he too would also avoid the securities due to their potential short duration.

Equity, rates factors

“These no-call three months are very common. But we like to see a longer no-call period when we buy issuer call notes,” he said.

He explained the factors that may influence the issuer to call the notes.

The first one is based on the underlying equity component.

“If the S&P is below par in three months, they’re not going to call it,” he said.

That’s because the issuer would have to redeem the notes at par, which would be at a richer price than the value of the index on the call date.

“If the index is down, they won’t call you,” he said, noting that the issuer call in that regard is no different from an automatic call.

The second variable was the direction of interest rates.

“Even if the index is up, it doesn’t mean the issuer is necessarily going to call you because a second factor comes into play: the direction of interest rates,” he said.

“It’s a bond after all. If rates are up, why would they call the note and reissue a new one at a higher interest rate?”

“It’s in a declining interest rate environment that the odds of being called are the greatest.”

A function of the VIX

Overall, the volatility in the equity market as measured by the VIX index was a good indicator of callability, he said.

“The callability of the notes depends on the prevailing interest rate environment.

“Interest rates are 100% positively correlated with the VIX,” he said.

The traditional reasoning is as follow: investors buy riskier assets such as stocks in a low interest rate environment in order to generate returns they cannot find in bonds. The low interest rates environment tends to compress the VIX from this standpoint.

Putting the three variables together – interest rates, stock prices and volatility – he offered a big picture representing the various incentives an issuer may have to call the notes.

“If the S&P is up and rates are down, that’s a low volatility type of market, which typically will incite issuers to call the notes,” he said.

The opposite scenario – declining stock prices, rising interest rates and higher volatility, would have the opposite effect, he noted.

High maintenance

“For the regular adviser, that’s a lot of ifs, a lot of correlations,” he said.

“If you’re a small advisory boutique, the only way you can buy things like that is if you’re running a managed account. There you have someone dedicated to watching those notes. If they’re called, they restrike them and renew them into a new income note. It’s hands-of. They sit back. You and your clients don’t have to think about it,” he said.

Another possible interested party would be the broker selling structured notes in a wirehouse.

“The fee is embedded in the notes. Every time they call, they charge a fee. Each call generates a profit. For those people, it makes sense to buy a three-month no call,” he said.

But financial advisers with a small staff and limited operational capabilities are unlikely to be interested in those “high-maintenance” securities, he said.

“For them it’s a lot of work to prepare for a call each month, to have ongoing conversations with their clients before or after the notes are called and on top of that, having to worry about reinvesting the proceeds.”

The three-month “no-call” period was too short, he said even if most of the time, issuers do not call the notes right away.

“That’s one of the positive things... issuers don’t call right away. They tend to skip the first call.”

But this was not enough to convince this portfolio manager of the benefits of a note with an early first call.

“We tend to stay away from those three-month no-call. We want to see at least six months to a year,” he said.

CIBC Capital Markets and UBS Financial Services Inc. are the agents.

The notes settled on Monday.

The Cusip is 13608K245.

The fee is 0%.

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