UBS' $32.72 million autocallable tied to iShares Russell, SPDR drew high bid for coupon

By Emma Trincal

New York, Nov. 7 - UBS AG, London Branch's $32.72 million of 0% trigger phoenix autocallable optimization securities due Nov. 2, 2017 linked to the lesser performing shares of the iShares Russell 2000 index fund and the SPDR S&P 500 ETF trust was the top deal last week due to investors' search for yield, sources said.

However, the higher coupon came with more bells and whistles, adding risks to the structure, such as reinvestment and liquidity risk, they noted.

The product was a mix of different structures, including callable reverse convertible and worst of. The return was tied to two underlying funds that did not constitute a basket, with the worst performer determining the final outcome.

If each fund closes at or above the 59.16% trigger level on any quarterly observation date, the notes will pay a contingent coupon of 8% for that quarter. Otherwise, no coupon will be paid that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

The 8% rate is based on an annualized return.

If each fund closes at or above its initial price on any quarterly observation date after one year, the notes will be called at par of $10 plus the contingent coupon.

If the notes are not called, the payout at maturity will be par plus the contingent coupon unless either fund finishes below its trigger price, in which case the payout will be par plus the return of the worse performing fund.

Last week recorded a sluggish issuance volume with only two deals in excess of $20 million and none greater than $50 million. Still the UBS product was on top of the list, according to the most recent data compiled by Prospect News.

Too much risk, complexity

Andrew Valentine Pool, main trader at Regatta Research & Money Management, said that he could not understand why.

"The complexity is a concern. I can just see a puzzled look on a client's face wondering what I'm telling them," he said.

"Then you have the two funds. It's hard enough to get one item right, now you have to worry about two.

"The tenor is not to our liking. We think the economy will grow, albeit at a slow pace. But still, I wish I would know what would happen in five years. Five years is a long time if you end up not being called.

"Frankly, I am not sure I understand why this deal was a big seller last week.

"It's awfully hard to explain; it's long-term: if you're not called you're locked in for five years with little liquidity. You have a low barrier, that's true. But it's a soft protection. At maturity, if that threshold is hit, you're on for big losses; and in this scenario, your return is tied to the worst performing fund."

"Finally, I can't see how the risk reward works in your favor when you're taking all that risk for 8% per year, which is not even guaranteed," he said.

More coupon

Michael Iver, founder of iVerit Consultancy and former structurer, said that investors' hunger for yields helped explain the relative popularity of the product.

"If it doesn't get called, collecting an 8% return compounded over five years in a market where Treasuries are paying nothing just seems attractive," Iver said.

"On the downside, a 40% decline is a pretty big move, especially over a five-year period. If the market falls 40% you have a lot of bigger issues to worry about.

"People buy those deals for the coupon."

"And with low volatility levels, the way to get a higher coupon is by making the deal callable," he said.

Investors when they buy callable reverse convertibles calculate that they are likely to earn more coupon than a similar deal with no call feature, he explained. At the same time, they assume that the deal will not get called too soon, so that they can reach their target.

"It's not always possible to compare a callable note with its non-callable counterpart. But if you don't expect to be called before getting a coupon at least equal to or higher than what you would make with a non-callable, then this is the type of deal for you," he said.

"You get paid more for accepting the reinvestment risk. It's a trade-off."

The notes (Cusip: 90269V736) priced on Oct. 31.

The fees were 2.5%.

UBS Financial Services Inc. and UBS Investment Bank were the agents.

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