BNP Paribas’ autocalls on Russell 2000 more likely to offer premium than unlimited leverage

By Emma Trincal

New York, Feb. 1 – BNP Paribas’ 0% autocallable leveraged notes due Feb. 28, 2029 linked to the Russell 2000 index offer an innovative structure combining a traditional snowball with uncapped leveraged return at maturity. For advisers, the most likely outcome was the automatic call, and the key question was how attractive the call premium may be and/or how likely they may benefit from the growth opportunity at maturity.

The notes will be called automatically if the level of the index is greater than or equal to its initial level on any annual valuation date at a premium of 9% per year for the first four years, according to a term sheet.

The premium on the fourth and final valuation date is 36%.

If the index finishes positive, the payout at maturity will be par plus 150% of the index gain.

The payout will be par is the index declines but finishes at or above the 70% barrier.

Investors will lose 1% for every 1% that the index declines if it ends below the barrier.

Core position

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said the notes could be used to enhance the asset allocation of the portfolio.

“It’s a good tool for a core position in small cap,” he said.

“If I have for instance a 10% allocation to the Russell, expecting the index to take off, I might want to put 6% in this note. There’s a good chance of getting called and getting a good return.”

The other 4% could be invested in a more liquid instrument allowing him to reduce the size of the position in a timely fashion if needed, he added.

Medeiros said he also liked the five-year tenor.

“If the notes are not called right away but later, you’re still going to get paid the full 9% annualized return,” he said.

The cumulative return made the payout different from a typical contingent coupon autocallable note, in which missed coupons do not get paid later unless the structure provides a special feature called “memory.”

“You have the opportunity to get a cumulative return based on a full market cycle. That’s very attractive,” he said.

At maturity

The scenario at maturity was attractive as well.

A high index performance would be the best possible outcome as investors would benefit from the uncapped leverage, he noted. But such scenario implied missing the call four times in four years, which was unlikely, he added.

“If at maturity the Russell is up only moderately, at least you have the leverage enhancement, which is really helpful,” he said.

On the downside, the longer maturity would help mitigate the risk.

“I would be relatively comfortable with the 70% barrier only because it’s a five-year,” he said.

Not enough

Steve Doucette, financial adviser of Proctor Financial, said the notes did not offer enough upside.

“It’s hard to get excited about 9% when everybody is predicting that the market is going to go up,” he said.

“The 1.5x leverage with no cap is nice. But what are the odds that you’ll get it?”

One possible reason for the notes not to get called on any of the four consecutive years would be a prolonged market downturn.

“If we go through a bear market you end up at maturity with a very small gain.

“What difference does it make then to get 1.5x the upside and no cap if you have a ridiculously low return?

“The odds are very high that you’ll get called and collect 9% per year,” he said.

For Doucette, the premium, which is also a cap, was not compelling enough based on the Russell’s historical returns.

“Small-cap have outperformed large-cap over the past 20 years.

“If the Russell starts to run, you could really be missing out a lot.

“That wouldn’t be a note I would want to buy,” he said.

Another concern was the long tenor.

“We could go up and down in five years. That’s another problem. It’s hard to tell where the market is going to be in five years,” he said.

“Maybe this note needs to be shorter in order to improve it.”

Decent return

Julian Rubinstein, chief executive of American Asset Management, said he liked the risk-adjusted return.

“It’s a good note,” he said.

Rubinstein routinely runs back-testing analysis to evaluate the downside risk of a security. Using five-year rolling periods going back to 1992, he found that the Russell 2000 index only breached the 70% barrier twice.

“I would prefer a probability of breach of 0% but it seems fairly safe,” he said.

The automatic call at par also contributed to lower risk.

“You can get called each year for four years. That makes the note even safer. You get your principal back plus a premium. You have four opportunities to see this event happen,” he said.

This would only be a problem for investors expecting much more upside.

“To me the 9% premium seems like a decent return,” he said.

Growth instrument

Rubinstein said that if he decided to use the notes, it would not be for income replacement.

“It’s an autocall, not a guaranteed income,” he said.

“I would use it for growth, some sort of safer way to generate growth.”

He declined to say whether 9% could reflect a bullish or mildly bullish view.

“It’s not about being bullish or bearish, although I’m always bearish. It’s my job,” he said.

For this adviser, the risk-adjusted return analysis prevailed.

“I would look at the probabilities of getting paid.

“Getting a 9% cumulative premium and a 70% downside protection at maturity seems pretty reasonable to me. You can’t have everything,” he said.

Making it real

Rubinstein compared this structure with a so-called “catapult” note.

Catapults also are autocalls that offer the uncapped leverage at maturity. The difference is that there is only one autocall observation and usually early on, not several.

“Here with four annual observations, the chances of getting called are obviously much higher,” he said.

“You shouldn’t buy this note hoping to get the leverage with no cap at maturity.

“It’s a great outcome but not a very likely one.”

For investors who do not expect to hold the notes to maturity, a change in the structure could be considered.

“If you’re convinced that you’ll get called at some point, it may make sense to eliminate the uncapped leverage at maturity and make the note a regular snowball with five annual autocalls.

“By eliminating the leverage, you might also be able to raise the call premium,” he said.

BNP Paribas Securities Corp. is the agent.

The notes will price on Feb. 26 and settle on Feb. 29.

The Cusip number is 05611LVM2.

The fee is 3%.

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