JPMorgan’s contingent income autocallable notes use unusual indexes in worst-of structure

By Emma Trincal

New York, April 22 – JPMorgan Chase & Co.’s contingent income autocallable securities due May 5, 2022 linked to the worst performing of the Russell 2000 index, the Euro Stoxx Banks index and the Hang Seng index use a standard worst-of structure with some not-so-common underlying indexes, a market participant said.

The structure is called a “worst of” because the payoff is tied not to a basket return but rather to the individual performance of each index.

Hang Seng

“It’s interesting. We see a lot of S&P and Euro Stoxx or S&P and Russell 2000 worst-of deals. But the Hang Seng in a worst of ... I don’t think I’ve seen it,” the market participant said.

The Hang Seng index tracks the performance of the Hong Kong stock exchange.

The use of the Euro Stoxx Banks index, a European sector index, is also uncommon in a worst of.

“The underlying indexes are interesting in this deal,” he said.

The notes will pay a contingent quarterly payment of at least 2.5% if each index closes at or above the 75% coupon barrier level on the determination date for that quarter, according to an FWP filing with the Securities and Exchange Commission.

The notes will be called at par plus the contingent coupon if each index closes at or above its initial level on any determination date other than the final date.

The payout at maturity will be par plus the final coupon unless any index finishes below its 60% downside threshold level, in which case investors will be fully exposed to the decline of the worst-performing index.

Correlation

“You have a 75% coupon barrier with a lower principal barrier at 60%. It’s interesting. Not the same level, although that’s not unheard of,” he said.

“It’s an autocallable, so obviously it could be shorter than seven years.

“The deal gives you 10% a year in contingent coupon, which isn’t bad.

“It looks like it’s well priced, although you could say the price is always right as long as banks don’t lose money and people buy it.

“In this case though, there’s a reason they can give you that income. You’re not buying a basket of three indexes. It’s a worst of, and pricing is based on correlation.

“Since those three indexes are not correlated, the issuer was able to price the deal attractively.”

Tenor

“The tenor is attractive too, not just the coupon. It’s a seven-year. It looks like a long maturity, but in reality, that’s short for a worst of based on indexes. You can do stock deals much shorter than that but not with indexes. Once you go for a worst of on indexes, you’re looking at 10 years,” he said.

The low correlation between the U.S., euro zone and Chinese benchmarks allow the issuer to offer a 10% annualized coupon on seven years because the risk rises along with the premium when correlation decreases, he said.

“The odds of not getting paid are greater because you need all three indexes to be above the 75% level. The low correlation adds to the risk of losing principal too, even with a 60% barrier. All it takes is for one of the three indexes to ... breach the barrier, and if they move in different directions, such risk increases,” he said.

Slot machine

Win Thin, senior currency strategist at Brown Brothers Harriman & Co., who covers Asian markets, criticized the structure itself. The fact that all three indexes have to be above a particular threshold in order for investors to earn the coupon, see the notes called or get the full repayment of principal at maturity reduces the odds of a positive outcome, in his view.

“It really looks like pulling a slot machine. You want all three cherries to line up and you get the jackpot. If they don’t, you get nothing or you lose. I find it unnecessary complicated. I know it’s hard to get a coupon, but there are too many moving parts in this,” he said.

Win said the timeframe is not short for investors.

“Seven years is a lifetime. A lot could happen in seven years,” he said.

Bull market

The Hang Seng is probably one of the most appealing parts of the deal, although one with risk.

“The Hang Sang is at its highest level since 2007-08. Even though Chinese growth is slow, the government is adding stimulus and talking up stocks. The market is going with this,” he said.

“The result is impressive: the Hang Seng has gained 24% over the last 12 months. It’s up 18% for the year.

“It’s a very big mover. Chinese stocks are on a tear, and many investors are jumping in. Obviously, the higher it goes, the more risk it may fall. There’s no way to tell.”

J.P. Morgan Securities LLC is the agent. Morgan Stanley Smith Barney LLC will handle distribution.

The notes are expected to price April 30.

The Cusip number is 48127T368.

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