These 100 Auto-callable Notes Lost $1 Billion

By Craig McCann and Mike Yan

Last March, we posted four short articles on auto-callable structured products.

In Autocallables 2024 (March 25, 2024) we noted that $122 billion of auto-callable structured products had been sold in the prior 4 years, mostly issued by UBS, Goldman Sachs, JP Morgan, Citigroup and Morgan Stanley. You can read that post here.

In Autocallables 2024 Part II: Lucid-linked Notes (March 26, 2024) we illustrated features of autocallables using five notes linked to the stock price of Lucid issued by Credit Suisse and Citigroup in a post available here.

In Autocallables 2024 Part III: SVB, Really? (March 27, 2024) available here, we pointed out a particularly poorly timed issuance by Citigroup linked to Silicon Valley Bank stock.

In Autocallables Part IV: Issuers' Day-1 Value Mischief, (March 28, 2024) available here, we explained how some issuers inflate the fair market value of newly issued notes prominently displayed in the 424b filings.

We said that a fifth installment reporting 100 autocallables with large losses would follow shortly after those four posts. Nearly a year late, we finally make good on that commitment.

Introduction

Determining which auto-callable structured products have suffered any principal losses and identifying the products suffering the largest losses are Herculean tasks. Issuers don't submit data on whether their structured products pay coupons, are called, pay face value at maturity or pay out something substantially less than face value at maturity to vendors like Bloomberg. Instead, an analyst interested in determining the payoffs to auto-callables needs to laboriously gather mountains of data and perform complicated calculations.

First, the analyst needs to download 424bs for all auto-callables - over 50,000 in just the past four years. She then must extract an extraordinary amount of detailed data from each 424b including principal amounts, pricing dates, issue dates, valuation dates, maturity dates, call and contingent coupon observation dates, and thresholds levels for determining calls, coupons and conversion values at maturity. There is significant variation across issuers - even over time for the same issuer - in how this information is placed and described in the 424bs making a difficult task almost impossible.

Once these parameters are gathered, the value of the underlying assets on call, coupon and maturity dates must be compared to determined whether the notes were called on call observation dates or survived to maturity. If the value of the underlying asset, or of the worst performing of multiple underlying assets in the case of worst-of-basket auto-callables, was below its value on the issue date on every observation date, the note survived to maturity. The analyst then determines whether the note was settled for less than face value at maturity.

Based on SLCG's analysis, the 100 largest principal loss auto-callables had $1,014,862,450 in losses or 55.1% of their $1,840,464,855 face value. $234 million of these principal losses are on notes issued by Goldman Sachs. JP Morgan, UBS, Morgan Stanley and Credit Suisse also each had losses in this select group of 100 auto-callables of $100 million or more.

We noted in an earlier post that UBS, Credit Suisse and Bank of Montreal appeared to inflate the issue date values they placed on the 424bs. It may be a coincidence but among these 100 largest loss auto-callables, UBS, Credit Suisse and Bank of Montreal's notes suffered a 62.6% blended principal loss while the other nine issuers' notes had a blended principal loss of 53.4%.



Our 100 auto-callables with the largest losses are listed in Table 3 below.

The largest single loss is on a three-year JP Morgan note linked to ViacomCBS issued on June 11, 2021 when ViacomCBS closed at $42.35.

The first time on any of 11 quarterly observations dates ViacomCBS closed above $42.35, JP Morgan would call the note at par plus a quarterly coupon. So long as ViacomCBS closed below $42.35 but above $27.5275 (65% of $42.35) on quarterly observations dates, JP Morgan paid a quarterly coupon and the note continued uncalled to the next observation date.

If the note survived until maturity, JP Morgan paid face value if ViacomCBS closed above $27.525 at maturity. If ViacomCBS closed below $27.525 on the note's maturity, JP Morgan paid the ratio of the closing price and $42.35 multiplied by the $10 face value.

ViacomCBS did not close above $42.35 on any observation date so the note was never called.

ViacomCBS closed above $27.5275 on each of the first three quarterly observation dates and so the first three coupons were paid. ViacomCBS closed below $27.5275 on each of the remaining nine quarterly observation dates so no further coupons were paid.

ViacomCBS closed at $11.04 or 26.07% of the closing price on the $42.35 issue date so investors received $2.607 per $10 face value, suffering a 73.93% principal loss totaling $28,396,499.



We will post a further explanation of this and other notes in subsequent posts.



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