JPMorgan’s one-year capped buffered notes linked to Euro Stoxx Banks offer contrarian bet

By Emma Trincal

New York, Sept. 11 – JPMorgan Chase & Co.’s 0% capped buffered equity notes due Sept. 30, 2015 linked to the Euro Stoxx Banks index may offer a contrarian or value play for investors bullish on and familiar with the sector, sources said.

The payout at maturity will be par plus any gain in the index, up to a maximum return of 24.45%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to the 15% contingent buffer and will be fully exposed to the index’s decline if the index finishes below the 85% barrier level.

Contrarian

“I’d like to see a little bit more downside protection because it’s potentially a volatile sector,” said Matt Medeiros, president and chief executive of the Institute for Wealth Management.

“On the other hand, you can look at this note as a contrarian play. The sector is so undervalued; I think the 15% downside is still OK.”

The Euro Stoxx Bank index is one of 19 Euro Stoxx “Supersector” indexes that compose the Stoxx Europe 600 index, which contains the 600 largest European stocks by free float market capitalization, according to the prospectus. The Euro Stoxx Banks index currently includes 29 stocks of top banks mainly from the 12 largest euro zone countries.

Sector bet

Steve Doucette, financial adviser at Proctor Financial, said the structure is “not bad” but that he would avoid sector bets.

“Over one year, it’s good to have a 15% protection, although it’s not a hard buffer. They couldn’t have done it with a hard buffer,” he said.

“You still get relatively good terms. But it all depends on what your outlook on the European banking sector is and if you expect those banks to do anything. There is so much uncertainty around the euro zone economic growth. Rates are so low. Not a bad structure, but it all depends on where you want to put your money.

“I guess it’s a nice play to park your money if you have a bearish outlook. You do have some downside protection, and you might capture the upside if that’s part of your asset allocation plan.”

But banks in general over the past decade have underperformed both in Europe and in the United States, which for Doucette is a concern.

Laggard

“I don’t spend a lot of time looking at subsectors, but in general banks have not been appreciating at the rate the rest of the market has,” he said.

“If you look at the U.S. market and compare the SPDR S&P Bank ETF with the broader S&P 500 over the past 10 years, the difference is telling.”

The sector ETF has lost 36% over the past decade while the S&P has gained 77.5%.

This ETF has been renamed “SPDR KBW Bank ETF.”

“Now if you look at the European market, the Euro Stoxx Banks index has lost 15.87% over the past 10 years while the broader Euro Stoxx 50 has gained 20.5%,” he said.

“Banks have been lagging the broader market to such a point it makes you a bit cautious.

“But someone might look at it differently. If you think the sector has been beaten down and that banks may come back, you could consider it.

“For me though, I can’t get excited about it. Interest rates are low, and banks make their money on interest rate spreads.”

Rates and margins

Dick Bove, financial services analyst at Rafferty Capital Markets, LLC, explained the relationship between low interest rates and banks’ profit margins.

“If you’re a bank and the deposit rates come down, it should be a good thing in theory as it lowers your cost of funding. But near-zero interest rates don’t leave much room for rates to come down,” he said.

“On the other side, lending rates as they come down reduce your income as a bank. If the cost of your liabilities doesn’t go down as much as the income you get from your assets, you’re not going to make money. When that spread tightens, it has a negative impact on banks’ margins.”

For less risk-averse investors who follow the sector, the structure offers opportunities, said Doucette.

“Maybe if banks jump up you can capture some of the upside. If things get ugly, you get the protection up to 15%, which isn’t bad on a sector that has been lagging for years,” he said.

“If we have a correction, banks may pull back less than the broader sector and you may be better off.

“But you get into the nitnoid of the sector details at this point. We as a firm really tend to look at the bigger picture.”

Country picking

Medeiros is bullish on Europe but would select carefully the countries in which he would invest given the uncertainty around the economy in the euro zone.

“Although I’m not in favor of having a cap on the underlying, 24% is reasonable for this period of time,” he said.

“However, if I’m going to invest in Europe or in a European sector, I would be more country-specific rather than looking at the whole region.”

The Euro Stoxx Banks index includes stocks of banks located in countries that have suffered through the euro zone sovereign debt crisis of 2010-12, such as Greece, Ireland, Italy, Portugal and Spain, he noted.

Economic uncertainty

“I am optimistically bullish on Europe, and if Europe has to have a recovery as we’re hoping it does, financials must participate,” he said.

“One issue, however, is the monetary policy. Europe is cutting interest rates, and right now the market expects that the lower rates will boost the European economy. But at the same time, it may also create tighter margins for banks.

“Just because rates are down does not mean European banks are going to lend more, especially if Europe is struggling economically.

“The opportunity for economic growth exists in Europe, but it varies widely from a country to another. That’s why my biggest concern with this note is not the sector but the region. I would much rather pick my own European countries.”

J.P. Morgan Securities LLC is the underwriter.

The notes were expected to price Friday and will settle Wednesday.

The Cusip number is 48127DZW1.

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