Deutsche Bank’s notes linked to S&P 500 index designed to outperform in slow-growth market

By Emma Trincal

New York, June 10 – Deutsche Bank AG, London Branch’s 0% notes due August 2017 linked to the S&P 500 index have a structure that at first glance doesn’t appear to “stand out,” said Tim Vile, structured products analyst at Future Value Consultants.

But for investors looking to outperform the benchmark in a limited-growth environment, the leverage factor and buffer applied to a short period of time may be beneficial, he said.

“Nothing stands out, at least that’s the first impression you get. But you still get double the return with a buffer on a 14-month note. The cap is what it is. You just can’t be too bullish if you buy this note,” he said.

The payout at maturity will be par of $10 plus 200% of any index gain, subject to a maximum return that is expected to be between 8% and 12% and will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index declines by up to 5% and will lose 1% for each 1% decline in the index beyond 5%.

Moderately bullish

“It’s for mildly bullish investors only. But you still have to be bullish because if the S&P doesn’t go up, you’re not getting anything. It’s not like an autocallable contingent coupon deal or a digital,” he said.

Picking the middle of the range, 10%, for the cap, Vile said that the maximum return available to investors is 8.48% per year on a compounded basis. That level can be achieved if the index increases by 4.30% a year.

“You’re not expecting much growth. That’s part of the way leverage is priced. When you have a good level of leverage – and two times is pretty good – you can expect quite a low cap on the S&P. That’s because there’s not much left to raise the cap,” he said.

Investors in the notes would have to be “reasonably cautious” despite the small 5% cushion. Having a buffer on a short-term note probably reflects the profile of an investor willing to reduce some of the upside in exchange for some level of protection, even a small one, he explained.

Market risk

Future Value Consultants evaluates risk, return and price using a variety of proprietary scores in order to compare a product with others, including peers and all products.

Peer products in this case, or those that fall in the “same product type” category, are leveraged return notes. Those products may or may not be capped. Some offer protection while others do not. The common ground is an upside participation rate in excess of 100%, he explained.

For the risk, Future Value Consultants produces its own metric, the riskmap, which measures the risk on a scale of zero to 10 with 10 as the highest level of risk possible. The riskmap is the sum of two components, market risk and credit risk, both calculated on the same scale.

The market riskmap for the notes is 2.10 versus an average of 3.84 for the product type and 3.36 for all products, according to the firm’s research report on the notes.

“Even though 5% is not a lot, at least you get a buffer. It still limits the amount of capital at risk,” he said.

“Also the S&P 500 is not the most volatile underlying, which also helps.”

Credit risk

The credit riskmap is 0.46, slightly more than the 0.41 average for leveraged return notes.

“It’s more if you take into account the product’s duration. Over such a short term you would expect a lower-than-average credit riskmap,” he said.

“It’s probably credit-related. A better credit would have raised the credit riskmap in this case.”

Deutsche Bank has seen its credit deteriorate as reflected by its credit default swap rates, which, at 188 basis points, remain wider than other European banks, according to data from Markit.

Credit Suisse has spreads of 139 bps, but Societe Generale and BNP have 86 bps and 87 bps spreads, respectively. UBS has CDS spreads of 76 bps.

Return

Future Value Consultants measures the risk-adjusted return on a scale of zero to 10 with its return score. This rating is calculated based on the best among five market scenarios, which for this particular product would be the bullish scenario.

The return score is 6.79 versus an average of 7.42 for similar products and 6.45 for all products.

“While the riskmap is very low, the cap drags down the risk-adjusted return,” he said.

“You’re comparing this note with other leveraged products that can be uncapped or have higher caps. Any cap on this type of structure, especially over a short period of time, will bring the return score down.”

At the same time, the notes deliver some relatively good value to investors as illustrated by the price score.

Price score

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10.

This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

The notes have a 7.39 price score. The average for the product type is 7.55.

“It’s really not bad given that it’s a very short-term product. Short-dated notes don’t score very well on the value scale because we calculate the fees on an annualized basis, so there is less time to amortize the cost,” he said.

Value and outcome

While both the return score and the price score are less than average for the product type, the price score is relatively better, he noted.

Price score and return score are correlated, he explained. But they are still leading to different conclusions.

“The relatively strong price score suggests that the issuer spent enough on the options to give investors some reasonable value,” he said.

“You still have decent leverage; you get a buffer; and there is an 8.5% potential return.

“Even though the cap is low, they still spent money to provide those terms.

“The low cap pushes down the return score, but it doesn’t mean there’s no good value in there.”

Overall score

Future Value Consultants offers its general opinion on the quality of a deal with its overall score. This metric is simply the average of the price score and the return score.

The overall score is 7.09, compared to the average of 7.48 for similar products and 6.31 for all product types.

BofA Merrill Lynch is the agent.

The notes will price and settle in June.

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