BNP Paribas’ autocallable dual directional notes on banking ETF offer solid prospects for bears

By Emma Trincal

New York, Oct. 6 – BNP Paribas’ 0% autocallable notes due Oct. 5, 2026 linked to the SPDR S&P Regional Banking ETF give bearish investors a chance to outperform the ETF given the dual directional feature and its range as well as the rising likelihood of a recession, said Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments.

The notes will be called automatically at par plus a premium of 14% if the ETF closes at or above its initial level on Oct. 2, 2024, according to a term sheet.

If the ETF finishes at or above its initial level, the payout at maturity will be par plus the return.

If the ETF finishes negative but at or above its 60% barrier, the payout will be par plus the absolute value of the ETF return.

Otherwise, investors will be fully exposed to the decline of the ETF from its initial level.

“At maturity, you can really make money on the downside as long as it doesn’t fall by more than 40%,” said Kaplan.

“You can also do very well in one year if the ETF is flat or up. The call premium gives you a very positive result,” he said.

Generating alpha

Kaplan defined the range where the note will outperform the underlier based on unpaid dividends.

The SPDR S&P Regional Banking ETF has a dividend yield of 3.7%, which represents an opportunity cost of approximately 12% over three years on a compounded basis.

“Is using the note going to be better or worse than buying the ETF? It all depends on your return,” he said.

The breakeven point is minus 6% on the downside and plus 12% on the upside, he noted.

“You just don’t want to fall within that range, between minus 6% and plus 12%; otherwise, you might as well be long the ETF.”

Investors in the note are hoping to see a decline of more than 6% but less than 40%, he said.

“That’s the sweet spot. In that pretty wide range, the note will outperform,” he said.

On the upside, investors need to see the final price above +12% just to match the fund’s total return.

But at maturity, the upside offers no particular advantage, he said.

Only the call premium may allow the note to outperform the ETF.

Contrarian signals

The initial price of the ETF on the trade date was $41.77, which set the barrier price at $25.06.

This would bring the price back to the low of March 2020 during the pandemic sell-off, he said.

“The chances of being down to this level are extremely low. If you had an American barrier, it would have been more likely, but not point-to-point,” he said.

The term “American” designates a barrier, which can be observed on any trading day.

Given the absolute return, the notes are more bearish than bullish, he said.

“You make more money on the downside.”

That’s if the notes mature. Another possible scenario is the autocall after one year, which triggers the 14% premium.

Kaplan said the call scenario had a high probability of occurring.

“KRE has already been the object of a lot of negative press since the regional banking crisis,” he said.

The SPDR S&P Regional Banking ETF plummeted in March following the collapse of Silicon Valley Bank and Signature Bank at that time.

“Many insiders are now buying. A lot of the negative news is already built in the price,” he said.

Kaplan said he hasn’t bought any shares of the ETF yet, waiting for a few more triggers.

“I’m waiting for a lot more insider buying. I also need to see a higher VIX, somewhere in the 30’s. Finally, I want to see bigger outflows,” he said.

Company insiders, through their buying and selling, offer clues about the future of a company, he explained. Typically, insiders buy when they are optimistic about the business or when the price has dropped sharply due to market reactions, which are not necessarily driven by fundamentals.

Beaten up

If the notes do not get called, Kaplan said the ETF would likely finish negative due to overall market conditions. However, he does not expect the minus 40% barrier level to be breached.

The initial price of $41.77 has declined from its $79 high of January 2022.

“It’s down almost half. Not too many sector ETFs are down by half,” he said.

The current valuation makes it less likely that the price would drop more than 40% at maturity, he noted.

“The S&P and the Nasdaq have much more room to fall than this ETF, which is already very depressed,” he said.

De-inverting

Kaplan expects more volatility in the market in the three-year timeframe.

He explained why.

The first factor was the de-inversion of the yield curve, which recently accelerated beginning only a few weeks ago, he said.

“We will get to a positive slope in the next three years and it’s not necessarily a good thing for the market,” he said.

“We’re seeing this trend already with the 10-year Treasury yield rising sharply.”

The U.S. Treasury yield curve is no longer inverted and is currently flattening, he noted.

“It’s in part driven by longer-term yields rising faster than short-term rates,” he said.

In theory a steeper yield curve tends to be supportive for banks as those no longer have to borrow at higher rates than the interest they collect on their long-term loans.

Recession coming

But depending on how the curve steepens, the result may be negative for the economy, he said.

“When long-term rates are coming up, businesses have a hard time borrowing long-term, and that’s the case for a lot of tech companies. Mortgage rates keep on going up and you start to see more defaults and foreclosures,” he said.

The same applies to credit card interest rates and car loans.

“At some point fewer people want to borrow money,” he said.

These recessionary forces by far will offset the benefits banks may gain from an improved balance sheet.

“Bank stocks are just a few stocks. If you’re in a severe bear market, all sectors will collapse,” he said.

“That said, I don’t believe KRE will drop more than 40% in three years. The share price is already too undervalued.

“There’s a risk of course, but less of a risk than other sectors or stocks.”

BNP Paribas Securities Corp. is the agent.

The notes were expected to price on Sept. 29 and to settle on Oct. 4.

The Cusip number is 05610P7G4.

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