BMO’s autocalls enhanced return notes on S&P offer high likelihood to gain short and long term

By Emma Trincal

New York, June 20 – Bank of Montreal’s 0% autocallable barrier enhanced return notes due July 6, 2026 linked to the performance of the S&P 500 index present high probabilities of success for investors whether the market declines short term or rallies over a longer timeframe – two reasonable scenarios to bet on, advisers said.

The notes will be called automatically at par plus an 11.6% call premium if the index closes at or above its initial level on July 8, 2024, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 150% of any index gain.

Investors will receive par if the index falls by up to 30% and will lose 1% for each 1% of index decline if it falls by more than 30%.

Steven Foldes, wealth manager and founder of Evensky & Katz / Foldes Financial Wealth Management, said the call premium was appealing based on the current state of the market.

“11.6% is an attractive coupon now that we had a 20% increase from the bottom of 2022,” he said.

“I don’t recall seeing something as attractive as this. I have seen this structure before but with much lower coupons and when the market was much lower, so at that time, you were likely to miss some of the upside.”

Credit

S&P Global Ratings assigned an A+ rating to Bank of Montreal. In comparison, Morgan Stanley, Bank of America and JPMorgan have A- ratings from the credit rating agency.

“Clearly in any note, the issuer is critically important. With a single-A rating from S&P, BMO has a very good credit in line with the big U.S. banks,” he said.

Fee, term

On caveat with the notes was its cost.

“The fee of 1.2% is a little high, particularly since it’s likely that it will be called after one year,” he said referring to the fee amount disclosed in the prospectus.

In addition, the tenor of the note was slightly longer than what Foldes usually looks for in a note.

“We don’t do three-year notes. If I was negotiating with the issuer, I would probably try and get a two-year and I would recognize that the leverage factor would be less.”

Three-year

In the absence of a call, investors could use the notes as a pure bullish play.

Even though the S&P 500 index had a strong recovery from the lows of October, with the index officially in a bull market, it remains nearly 9% lower than its all-time high, he noted.

The S&P 500 index peaked on Jan. 4, 2022 at 4,818.62 and closed at 4,388.80 on Tuesday.

“I fully expect that within the three-year period we will be hitting new highs and that the note will mature in positive territory,” he said.

“The headwinds that we have right now –The Fed’s hikes protocol, the war in Ukraine – in all likelihood will be resolved when the notes expire. So having a 150% return enhancement with no cap is very attractive.”

Downside

Foldes had no objection to the barrier size. But he said he would change the type of protection.

“The idea of having a 70% barrier is nice after three years. But I would try to convert this barrier into a hard buffer so that in the event of a 30% decline, you are not fully exposed,” he said.

In conclusion, Foldes’ view of the note was positive.

“I like the issuer’s credit. I like the use of the S&P, which everyone understands. Having an 11.6% coupon if the market does not fall at the end of the first one year is great. The uncapped leveraged return at maturity is nice. I would just try to shorten the term and replace the barrier by a buffer,” he said.

“But we will definitely consider this.”

Likely call

A financial adviser also liked the call premium and the conditions to meet in order to earn it.

“All you need is the S&P to be flat or positive in one year and you’re getting this 11.6% return. I would say this is really, really good,” this adviser said.

“You have a 74.5% chance of getting called after one year historically speaking,” he said.

“That’s three out of four chances of getting your 11.6%.”

A call premium of 8% or even 9% would not have been enticing enough, he noted.

“But an annualized 11.6% rate of return is above the historical average of the S&P, which is about 10%. If I can get that in a year even if the index is flat, I look at that as a win,” he said.

Recession bet

Should the call fail to occur, investors were still looking at a positive scenario, he said.

“People who still think there is going to be a recession in the next 12 months are going to have the three-year timeframe in mind.

“In fact, if the market is down in one year, it will probably be due to a recession, which may or may not happen and will not last for two years.

“In that case, you have that 150% leverage and uncapped return. Not a bad scenario,” he said.

Downside risk

The downside protection was “very good” although “not perfect,” he said.

“Historically, there is a 2.7% chance of breaking the 70% barrier. A 65% barrier would obviously be better, with only a 1.1% chance.”

But overall, the risk of breaching the barrier remained very small, he noted.

In the three-year duration scenario, which grants uncapped leveraged participation to noteholders, the main question is whether two years is enough for a recovery since the second year starts on a negative footing, he said.

“In all likelihood, the answer is yes because the market rises stronger and faster after a pullback.”

For instance, if the S&P declined by 20% on the first year, it would need to rise 17% a year on each of the following two years in order for investors to get at maturity a 10% annualized return, he said.

“That is completely reasonable after a downturn. And your 10% a year would be before leverage. Your real annualized rate of return would be 15%,” he said.

Short, long terms

The payout in two sequences offered positive outcomes for bulls and moderately bearish investors alike, he said.

“The timing of this note is just right. There is a fairly good chance of getting either your 11.6% return if the market is up short-term or a positive return long-term,” he said.

“You could be bearish short term. This note is actually designed for someone expecting a recession in the next 12 months. You then get called out with a nice 11.6% gain. If you’re wrong – and that’s a good thing, you get a leveraged return with no cap over a three-year period. Both scenarios look pretty attractive to me.”

BMO Capital Markets Corp. is the selling agent.

The notes will price on June 30 and settle on July 6.

The Cusip number is 06374VWS1.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.