JPMorgan's return notes on MSCI Italy, MSCI Spain SMID Cap to tap into 'PIGS' recovery theme

By Emma Trincal

New York, April 16 - JPMorgan Chase & Co. plans to price 0% return notes due May 6, 2015 linked to an equally weighted basket consisting of the MSCI Italy SMID Cap index and the MSCI Spain SMID Cap index. The offering comes on the heels of two similar offerings seen in the past 30 days, which suggests that weaker euro zone countries have regained the favor of the market, sources said.

Only two deals using this underlying basket have priced before, according to data compiled by Prospect News, which tracks filings since 2005.

The structure is that of a tracker.

For each $1,000 principal amount of notes, the payout at maturity will be (a) $1,000 multiplied by (b) one plus the basket return multiplied by (c) a basket adjustment factor of 99%. Because of the basket adjustment factor, investors will lose some or all of their principal if the basket return is less than 1.01%, according to an FWP filing with the Securities and Exchange Commission.

Mediterranean trend

The use of the MSCI Italy SMID Cap index and the MSCI Spain SMID Cap index equally combined in one basket is only recent and dates back to March. It was used in two offerings this year for the first time, with JPMorgan acting as a distributor.

The most recent pricing was on April 11 when JPMorgan priced $5.43 million of 0% return notes due April 29, 2015 linked to an equally weighted basket of the MSCI Italy SMID Cap index and the MSCI Spain SMID Cap index. The payout was exactly the same as the upcoming note.

Earlier, in March 21, HSBC USA Inc. priced $3.37 million of 0% notes due April 8, 2015 linked to an equally weighted basket of the Dollar-Adjusted MSCI Italy SMID Cap index and the Dollar-Adjusted MSCI Spain SMID Cap index.

HSBC Securities (USA) Inc. was the agent, and J.P. Morgan Securities LLC purchased the notes for resale, according to the prospectus.

PIGS are better

"The PIGS are coming back into favor. That's why you're seeing these deals," an industry source said.

The "PIGS" acronym refers to some of the Southern countries in the euro zone - Portugal, Italy, Greece and Spain - that encountered sovereign debt restructuring issues and fiscal problems.

"The Greek debt offering a couple of days ago, which was well-subscribed, suggests that this country is heading in the right direction," the industry source added.

Greece a week ago raised $4.2 billion, which was more than expected, at under 5% interest.

Performance

The two MSCI SMID Cap indexes are euro-denominated benchmarks that capture mid- and small-cap representations across the Italian equity market for the MSCI Italy SMID Cap index (94 constituents) and the Spanish equity market for the MSCI Spain SMID Cap index (49 constituents).

In 2013, the MSCI Italy SMID Cap index and the MSCI Spain SMID Cap index outperformed the MSCI World SMID Cap index by 17% and 15%, respectively, according to MSCI website. The Italian index rose by 41.63%, and the Spain index was up 39.18%, compared with a 24.38% return on the world benchmark.

In 2011, however, the country indexes underperformed the MSCI World SMID Cap index. The Italy index declined by 31.63%, and the Spain index lost 8.16%, compared with a 5.34% decline for the world index.

Access

"This is not just about the economic recovery of Italy and Spain. It's also a story of small- and mid-cap recovery in these countries," a market participant said.

"Access is also a very important drive behind those new themes. There's always interest in structured notes when you don't have an equivalent ETF.

"I don't think you have any ETFs on these particular indexes. You have an ETF for Italy and an ETF for Spain. But these are not small- to mid-cap indexes. That's when structured products come into play. If you don't have an ETF, it's a good idea to look for a structured note."

Currency neutral

One additional appeal of the upcoming deal is the currency neutrality it offers, the industry source said.

"What you're getting and what you're paying for is the non-exposure to the euro. These deals are currency neutral. That's why they're being done. That's the reason," he said.

The value of the notes will not be adjusted for exchange rate fluctuations between the dollar and the euro, according to the prospectus. As a result, if the euro appreciates or depreciates relative to the dollar, investors will not receive any additional payment or incur any reduction in their payment at maturity, according to the prospectus.

Notes linked to indexes that have component securities listed on a non-U.S. exchange do not always offer currency neutrality.

The $3.37 million HSBC deal that priced in March does not, and investors are exposed to currency exchange rate risk with respect to the euro, according to the prospectus.

Five-day averaging

The final basket level in the upcoming JPMorgan deal will be the average of the basket's closing levels on the five trading days ending May 4, 2015.

"The five days closing average is probably there out of necessity," the market participant said.

"From a manufacturing perspective, these markets don't offer easy access. The securities that comprise those indexes are not among the most liquid. Remember these are not broad indexes. The issuer has to do the buying and the selling themselves in order to structure the notes. When the notes mature, you want to be able to get execution when you unload your hedges."

The notes (Cusip: 48127DFF0) are expected to price April 17 and settle April 23.

J.P. Morgan Securities LLC is the agent.

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