BMO’s 0% autocallables linked to real estate fund offer good call premium for ‘anemic’ market

By Emma Trincal

New York, Oct. 28 – Bank of Montreal’s 0% autocallable cash-settled notes due Nov. 29, 2019 with a call premium linked to the iShares U.S. Real Estate exchange-traded fund give investors three chances to secure an equity-like return and possibly more than the underlying fund’s performance if the real estate market slows down over the next three years, sources said.

The notes will be called at par plus a call premium of 8% per year if the fund closes above its initial level on any annual call date, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par unless the fund finishes below its 85% trigger level, in which case investors be fully exposed to the fund’s losses.

A buy

“Eight percent a year and a 15% barrier? I’ll buy it,” a trader at a bank said.

“Everyone is talking about the Fed’s hiking rates. But the way central banks are going, it’s going to be easy money for at least 10 years.

“The Fed promised four hikes for 2016, and they’ve done nothing.

“They are not raising rates because they don’t want to raise rates. And they don’t want to do it because they’re scared of doing it.

“Meanwhile, the dollar is strong, and as it continues to go up, as inflation fears are picking up, you’re going to see some reactions on the long end. We’re seeing it already. Demand for TIPS is up, and long-term yields are rising. That’s a negative for real estate.”

Inflation expectations

Demand for real estate declines when investors worry about the impact of inflation on the value of their property.

The term TIPS stands for Treasury Inflation-Protected Securities, which are government bonds used as a hedge against inflation.

“We’ll see growth in real estate, but it’s going to be anemic. Getting 8% is a lot to pass up. I’m a buyer,” he said.

The iShares U.S. Real Estate ETF tracks U.S. stocks in the real estate sector, in particular real estate investment trusts.

A market participant said that as long as investors do not buy the notes for income, the risk-adjusted return of the product is appealing.

Not strictly income

“I prefer the ones that actually pay a coupon, but the economics look attractive. If you get called up, you get a very good return,” he said.

An autocallable note like this one is distinct from a reverse convertible autocallable paying a contingent coupon or a fixed interest rate, he said.

“It’s just different. This note allows you to catch up and cumulate the call premium. You miss the 8% on year one, you get 16% on year two. But whenever you get paid, you do get called up. The deal is finished. You can’t collect any more coupon,” he said.

Rare

The accumulation of premium when a call does not occur along with the call strike set at the initial level are fairly standard for pure autocall plays such as this one, he explained.

“The only difference is that if you get paid, you get out. It only happens once. So you can’t really call that income.”

Those types of autocallables are less common that contingent coupon notes with autocallable features.

Autocallable reverse convertibles with a contingent coupon represent $7.25 billion so far this year, or nearly 25% of the total issuance volume through Oct. 21, according to data compiled by Prospect News.

In comparison, only $628 million of autocallables, such as the Bank of Montreal deal, with call premium payouts were issued, which made for 2.15% of the total market.

“Obviously, people still like it, otherwise you wouldn’t see any of those at all. But there seems to be more demand for pure income plays,” he said.

“Perhaps it’s because it’s easier to get paid with the contingency. You can clip the coupon along the way with easier coupon barriers set below the initial price. This one, all things being equal, may give you better terms. The 85% barrier in particular looks quite good.”

BMO Capital Markets Corp. is the agent.

The notes will price on Nov. 28 and settle on Nov. 30.

The Cusip number is 06367TNB2.

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