BMO’s $1 million leveraged notes on Schwab offer deep barrier, 4x leverage

By Emma Trincal

New York, April 13 – Bank of Montreal’s $1 million of 0% barrier enhanced return notes due April 13, 2026 linked to the stock performance of Charles Schwab Corp. provide unusually high amounts of leverage and protection for those seeking exposure to a beaten-up stock, which has been penalized by the recent turmoil in the banking sector. Since the sector remains volatile, investors have to decide if the risk-reward is aligned with their own market and company outlook.

The payout at maturity will be par plus 400% of any gain of the stock, subject to a maximum return of par plus 75.2%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the stock falls by up to 50% and will be fully exposed to the decline of the stock if it falls beyond the 50% barrier level.

Bargain price

“The parameters are amazing,” said Steve Doucette, financial adviser at Proctor Financial.

“Getting a 50% barrier over three years is huge. It’s almost as if people were worried that Schwab won’t be able to make it.

“Schwab is in the crosshairs of the market right now.”

Charles Schwab closed at $48.87 when the notes priced. At that initial level, the stock was trading 44% off its one-year high of $86.63 posted on Jan. 9. The bulk of the price drop occurred in early March after the failure of Silicon Valley Bank.

“Almost half price! That’s a huge discount to get into the notes,” he said.

Cap, barrier

The 75.2% cap over three years represents a 20.5% annualized compounded return.

“Nothing to sneeze at. But with your four times leverage you’ll get to the cap awfully quick.”

Hitting the cap was all the more likely in the context of the recent big price drop, he said.

An investor buying the stock at the initial level of $48.87 would pocket the 75.2% return if the price ended at $85.62, he noted.

“That $86 cap is your recent high in January,” he said.

Holding the notes for three years to reach a price seen three months before made little sense, he said.

“You might as well get different parameters,” he said.

“I would give up some of the leverage so I can reduce or eliminate the cap.

“Three years out, if things turn around, Schwab could be off to the races.

He looked at the barrier in relation to the tenor.

“A 50% drop in three years would be pretty steep. Either Schwab would no longer exist, or the world would have to be pretty ugly,” he said.

The barrier price is $24.43, a level not seen since July 2016.

Balance sheet

Doucette said no one could predict what would happen to the brokerage firm in three years.

“You are buying a note tied to a single stock, so you are taking the company risk in addition to the market risk,” he said.

“I do not have an opinion one way or the other about Schwab. But there has been a lot of selling. Have they been hit by duration risk? Have they seen long-term assets drop in value without having enough short-term deposits to collateralize it?

“What about the effect of zero commissions or fee-cutting on profit margins? All brokerage firms are doing that but how does it impact the balance sheet?”

Some of those questions may be addressed when Charles Schwab reports its quarterly earnings before the open on Monday.

Revisiting the ranges

Banking risks arising from asset-liability mismatch are not limited to Schwab, he said, adding that investing in any financial or bank stock at the moment requires extra due diligence.

In the meantime, he would restructure the notes to reshape the risk-adjusted return.

“I would expand the most likely outcome. I would do a 60% or 70% barrier and with that, I would get rid of the cap,” he said.

“I probably won’t be able to keep the 4x leverage. I’d have to see how much I could get. But I would play with different parameters.

“My point is: if you’re going three years out with a stock price that’s already cut in half, you should get rid of the cap.”

Comfort zone

Matt Medeiros, president and chief executive of the Institute for Wealth Management, was very impressed by the level of downside protection. He also liked the stock.

“It’s a very attractive note. Schwab has proven to be a leader in the space and despite the recent turmoil, they will continue to be competitive as they have been previously through many, many market cycles,” he said.

The entry price combined with the downside protection offered solid defense.

“The note is struck at a very attractive time and at a price that’s considerably off from its high,” he said.

“Not only the entry price is already heavily discounted, but you also get a 50% barrier.

“I am very comfortable with that.”

No need for more

The 20% annualized cap was reasonable, he noted.

“Some may argue that it could be much more,” he said.

“But we’re living in times when it’s best not to be too greedy. There will continue to be some pressure on the financial sector. So, I’m not too concerned about the cap.”

Overall, his opinion was favorable.

“I can’t speak to the issuer’s creditworthiness. But the terms and the underlier seem attractive to me.

“It’s a good note,” he said.

BMO Capital Markets Corp. is the underwriter.

The notes settled on Wednesday.

The Cusip number is 06374VSV9.

The fee is 0.6%.

© 2015 Prospect News.
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