JPMorgan priced two autocallable offerings tied to Twitter with enticing coupons, short tenor

By Emma Trincal

New York, Nov. 24 – JPMorgan Chase & Co. priced last week two one-year autocallable offerings tied to the share price of Twitter Inc., one product paying a fixed interest rate, the other a conditional coupon. Both notes featured eye-catching double-digit coupons, advisers noted, yet they said they were wary about the products type, citing several factors from the underlying asset to the risk-adjusted return and structure type.

The first deal was a traditional reverse convertible with a fixed coupon. Payment at maturity was based on a so-called “American barrier,” which can be breached on any trading day during the term, according to a 424B2 filing with the Securities and Exchange Commission.

Two autocallables

JPMorgan Chase priced $1 million of 12.4% upside autocallable reverse exchangeable notes due Nov. 20, 2015 linked to the common stock of Twitter. Interest is payable monthly.

The notes will be called at par plus accrued interest if Twitter stock closes at or above the stock strike price on either of six call dates.

If the notes are not called, the payout at maturity will be par in cash, unless Twitter stock ever closes below the stock strike price by more than 45% and finishes below the stock strike price, in which case investors will receive a number of Twitter shares equal to $1,000 divided by the stock strike price or, at JPMorgan’s option, the cash equivalent.

The second deal, which was larger in size, offered a contingent coupon of a higher amount. The coupon and the call had different trigger levels. At maturity, the barrier determining how much of the principal investors may lose was a “European” barrier, which means it is observed on the final date.

JPMorgan Chase priced $12.59 million of contingent income autocallable securities due Nov. 19, 2015 linked to Twitter shares, according to a 424B2 filing with the SEC.

The notes will pay a contingent quarterly coupon at an annual rate of 17.5% if Twitter stock closes at or above the 70% downside threshold level on the determination date for that quarter.

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

If the notes are not called and Twitter stock finishes at or above the 70% downside threshold, the payout at maturity will be par plus the contingent payment.

Otherwise, investors will receive a number of shares of Twitter stock equal to $10 divided by the initial share price or, at the issuer’s option, the cash value of those shares.

Not fixed-income

Carl Kunhardt, wealth adviser at Quest Capital Management, said that none of the notes met his investment criteria.

“If I was going to do one of these, I would do the contingent one. Even if the reverse convertible one is not callable for the first six months, the call is much more likely to happen because the observation is monthly, not quarterly,” he said.

“At first I was leaning toward the first one until I realized how the buffer worked.

“You get a fixed income of 12.4%, which is nice, but you can lose your protection on any trading day. I wouldn’t want to go 360 days on a note if it only takes one day to see the barrier breach because at that point, you’re long the stock.

“A more basic problem for me with both deals is that you’re not going to get the full coupon. I don’t think you’ll see the maturity on either one of them. You’re getting called and most likely on the first observation date,” he said.

Another concern was the complexity associated with the structures, he noted.

“When I pick a note, it’s got to be simple to explain. Those are not. The second one has a less complex barrier but you have the contingency of the coupon and the two different strikes. It’s not my definition of simplicity,” he said.

Finally, Kunhardt said that it was unclear where the instrument would fit in a portfolio.

Equity risk

“You have to take a step back and wonder: is this structure type designed for income? Is it for growth? When you invest for income, you invest for a stream of income. You don’t really take a chance with your principal.

You don’t roll the dice. So it’s not for income. It’s not for growth either because your upside is capped by the coupon. You don’t participate in the stock gains,” he said.

“It’s a fine line between gambling and investing. You can call it investing because there is a reasonable expectation of some return. But as a planner, I can’t accept the premise of introducing significant risk – I’m talking about equity risk – for the purpose of collecting income. This is not fixed-income replacement because you introduce market risk,” he added.

Conceiving the notes as “equity proxies” was more realistic, he said, but still. Kunhardt said he would not view them as such.

“Typically as an equity product, I want to hold it longer. Most likely with the notes, I’m not going to pocket the complete 17.5% return for the year because in all likelihood, the notes will be called at the first call date. That’s not what I’m looking for when I want an equity proxy. When I want an equity proxy, I want participation.”

Kunhardt said that he did not see what the “value” of the notes was.

“People always say: structured notes belong in a portfolio. My question is: why? Nothing has an inherent right to belong to a portfolio. It has to bring value to a portfolio. Can you hedge with it? Can you enhance growth? These things do add value. But what do we have here? Two high-risk instruments that do not allow you to hedge or to enhance return. It doesn’t give me what I’m looking for in a structured note.”

No single names

Steven Foldes, vice-chairman with Evensky & Katz / Foldes Financial Wealth Management, said that autocallable notes were not a category of products his firm would invest in.

“We don’t do autocalls and we don’t do single-stocks,” he said.

“Obviously both notes are based on an individual stock and our whole focus is to invest in mutual funds, ETFs or structured notes that have exposure to an individual asset class.

“We don’t even focus on sectors.”

“If a client wants to invest in a stock, we implement the trade for them but treat that as a courtesy to the client. We don’t charge the client because we don’t manage it. We don’t get involved because of the risk involved,” he said.

Since most autocallable deals are linked to a single stock, Foldes said his firm has “no exposure to autocalls at all.”

While investors may or may not receive the full income payment, they are exposed to the full downside risk associated with the individual stock, he said.

“The tradeoff of getting some income from something we don’t like to own – an individual stock – this tradeoff is not a good one for us,” he said.

Fees eyed

Finally the fee structure of autocallable notes was not compatible with the business model of the firm, he said.

“I understand that these autocallables also come with high commissions,” he noted.

“We’re fee-only. We buy these products with zero commissions. We do a reverse inquiry. We send it out to firms. If there is a commission built into the product, it’s usually a reflection of what the terms are. But we don’t pay fees,” he said.

Foldes reassessed his main point: single stocks were not acceptable reference assets in his practice.

“We typically look at broad indexes, asset classes such as large-caps, small-caps, international emerging markets, developed countries etc.

“We don’t look at sectors. We don’t look at stocks.

“There is nothing wrong with sectors or stocks. But it requires understanding the fundamentals and being very nimble in terms of getting in and out,” he said.

Sources also noted the high volatility of the underlying stock.

Between December and May, the share price of Twitter dropped by two-thirds of its 52-week range. The stock closed on Monday at $40.19, which is 35% higher than its 52-week low in May but still remains nearly half the $77.75 52-week high observed in December.

The stock has an implied volatility of more than 40%.

The reverse convertible notes with the 12.4% fixed coupon priced on Nov. 18.

The Cusip number is 48127DW61.

The fees are 1.5% for all selling concessions.

J.P. Morgan Securities LLC is the agent.

The contingent income autocallable securities priced on Nov. 14.

The Cusip number is 48127P846.

The fees are 1.75%, with 1.25% in selling commission and 0.5% in structuring fee.

JPMorgan is the agent with Morgan Stanley Smith Barney LLC as dealer.

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