Deutsche Bank’s 0% leveraged notes linked to S&P 500 offer mildly bullish, short-term play

By Emma Trincal

New York, Aug. 1 – Deutsche Bank AG, London Branch’s 0% return enhanced notes due Aug. 19, 2015 linked to the S&P 500 index are designed for investors who seek to maximize their return over a short period of time on the view that the strong bull run may have run its course, said Tim Mortimer, managing director at Future Value Consultants.

The payout at maturity will be par plus double any gain in the index, subject to a maximum return of 13.2%. Investors will be fully exposed to any losses, according to an FWP filing with the Securities and Exchange Commission.

Capturing the upside

“This note offers some return enhancement with two-times leverage up to a 13.2% cap, which means that the index only has to go up 6.6% to get the maximum return of 13.2%,” Mortimer said.

“This trade is quite short-dated for a leveraged return product. Usually those are longer. The view is medium bullish.

“Given the strong performance of the S&P, investors considering this product are unlikely to expect strong growth ahead. They have a moderately bullish outlook and want to take a short-term view.”

The structure, however, does not offer any form of downside protection, which adds some risk.

“There is no barrier and no buffer, but one balancing factor is the short term. It’s a one-year. You’re not giving up much in the way of dividends, and you’re not taking on much credit risk,” he said.

Bullish investors considering the product would be willing to give up the downside protection for the return enhancement.

“The reward is 13.6% on top, a very decent return if you can achieve it with the market being up 6.6% in one year,” he said.

The leveraged upside in a modest-growth scenario gives noteholders a chance to outperform the market.

“This would be for an investor happy to forego any gains beyond 13% as they don’t expect much upside. They are still bullish, so they’re willing to take the downside risk in order to get double the upside,” he said.

Average risk

The risk associated with the product, as measured on a scale of zero to 10 by Future Value Consultants’ riskmap, is relatively average, according to the firm’s report. The notes have a riskmap of 3.00 versus an average of 3.37 for a group of leveraged return notes recently rated by Future Value Consultants.

“The absence of any barrier or buffer makes the risk higher than if you had some downside protection. However, the S&P 500 is among the less volatile indexes, so the reduced volatility somewhat offsets the lack of downside protection when comparing this product to others,” he said.

The riskmap is obtained by adding its two components: market riskmap and credit riskmap. The notes’ 0.42 credit riskmap is lower than the 0.59 average for the product type. This is due to the creditworthiness of the issuer and the short duration, he explained.

Future Value Consultants measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions: neutral assumption, bull and bear markets and high- and low-volatility environments. The best scenario in this case is bullish, he said. The notes have a 7.21 return score, compared with 7.77 for the average, according to the report.

“The return score is inhibited partly by the cap and partly by the lack of protection,” he said.

“We calculate the return score based on the bullish assumption, but it’s only one year. One year doesn’t really give the bull market a chance to fully work for you, which is why the return score is a little bit lower than average.”

Price score

The notes, however, priced competitively as measured by the price score, another rating from Future Value Consultants, which is also based on the zero to 10 scale.

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 price score for the notes is 7.87 versus 7.54 for the average leveraged return note, the report showed.

“The price score is slightly above the average, which indicates that the deal was competitively priced,” he said.

“This note is tied to the S&P, and it’s only one year, so there is plenty of liquidity to hedge it with options. It’s a very easy structure to replicate. It’s a simple, short-dated option. You just use a zero-coupon bond, you do a call spread, and you sell a put.”

Overall score

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. The score is simply the average of the price score and the return score.

The overall score for the product is 7.54 versus 7.66 for the average.

“You would expect a good price score with a simple, short-dated structure like this one, and that’s what we have here. The product priced well,” he said.

“On the other hand, the short tenor does not help the return score in a bullish scenario. The cap and the lack of any downside protection are not helping either. We end up with a slightly lower return score.

“But overall, one score offsets the other and we end up with a perfectly respectable product.”

The final index level will be the average of the closing index levels on the five trading days ending Aug. 14, 2015.

The notes (Cusip: 25152RMZ3) were expected to price Friday and will settle Wednesday.

JPMorgan Chase Bank, NA and J.P. Morgan Securities LLC are the placement agents.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.