JPMorgan's 10% notes tied to Royal Caribbean Cruises offer hybrid features, less risky profile

By Emma Trincal

New York, April 20 - JPMorgan Chase & Co.'s upside autocallable single observation reverse exchangeable notes due April 30, 2013 linked to Royal Caribbean Cruises Ltd. shares target income investors with a hybrid structure that combines features of a reverse convertible and an autocallable note but with less risk, said Suzi Hampson, structured products analyst at Future Value Consultants.

The coupon will be at least 10%. The exact rate will be set at pricing. Interest will be payable monthly, according to an FWP filing with the Securities and Exchange Commission.

The notes will be called at par plus accrued interest if Royal Caribbean stock closes above the initial share price on any of three quarterly call dates.

The payout at maturity will be par unless Royal Caribbean stock finishes below the 60% trigger level, in which case investors will receive a number of Royal Caribbean shares equal to $1,000 divided by the initial share price or, at JPMorgan's option, the cash equivalent.

Hybrid

Hampson said that her firm calls these products review reverse convertibles.

"It's somewhere in between a reverse convertible and an autocallable product," she said.

"In an autocallable, you get your payout as a call premium if the notes are called or at maturity. Here, you're getting your fixed interest payment regardless as long as you're not called. In that way, your return is safer. Even if you lose capital, the loss or a part of it will be offset against the return that you've made. So this reduces your potential amount of loss compared to an autocallable."

One of the main differences with a pure reverse convertible, she noted, is the type of protection.

"Reverse convertibles have a barrier that can be observed at any time. Here, you have a barrier observable at maturity. They call it a buffer; I'm not sure why. We call it a final-day barrier. If it's breached at the end, you have no protection left. In theory, you can lose your entire principal," she said.

"Because it's a final-day barrier, it's less risk than if the barrier can be breached at any time. So this is less risky than a reverse convertible from that point of view.

"In addition, this product is callable. Once you kick out, obviously you get your principal back and your coupon [and] there is no chance of hitting the barrier. As a result and compared to a straightforward reverse convertible, this is also a little bit less risk with this one."

Hampson said that the notes are designed for income investors seeking more yield. The return is limited to the 10% annualized coupon, and there is no participation in the upside.

"Your capital is still at risk, however, because once the barrier is breached, you have no downside protection," she said.

But this risk factor is reduced by the relatively low barrier, which at 60% and on a one-year tenor, provides for a competitive level of contingent protection, she said.

The automatic call may force investors to an early exit, according to the prospectus.

"This is a risk investors need to be comfortable with," she said.

"They're looking at the 10% return for one year. But they obviously could get 2.5% or 5% instead if they get called."

Early redemption

Anytime a note can be called, investors have to consider reinvestment risk.

"You have to have some tolerance for the idea of a kick-out. You really don't know in advance what the duration of your investment is going to be. There's an element of uncertainty," she said.

"Once you kick out, you may not find any equivalent product. And even if you do, it's expensive to reinvest four times in a different product as opposed to one for a year."

One element of risk arises from the 40% implied volatility associated with the underlying stock, she said.

"It's a short volatility play. It's high enough to give you a 10% annualized return and a pretty low barrier," she said.

The volatility of Royal Caribbean Cruises has been coming down over the past six months, she noted.

"You want volatility to fall because that gives you less chance of hitting the barrier," she said.

"The only thing you care about is whether you finish below the barrier.

"The downward trend in volatility over the past few months, if you expect that it will continue, may be your justification for this product."

Risk

The risk picture for this product is mixed as measured by riskmap.

Riskmap is a Future Value Consultants rating that measures the risk associated with a product on a scale of zero to 10. The higher the riskmap, the higher the risk of the product.

The riskmap for this product is 4.02.

Similar products, which in this case would be all products in the review reverse convertible category, have an average riskmap of 3.91.

"A lot of them are worst of, which are more risky than this one. On the other hand, most worst-of are linked to indexes rather than single stocks like this one," she said.

Worst-of products offer investors the worst return between two or more reference assets when a trigger is hit.

The JPMorgan notes, however, have a lower riskmap than the average of all products, 4.38.

"That's because you have a majority of reverse convertibles in the all-product category," Hampson said. "And they are more risky than this one for the reasons I mentioned, in particular, the day-to-day barrier and the often higher barrier level."

Risk-adjusted return

Future Value Consultants measures the risk-adjusted return with its return score.

At 6.11, the notes' return score is rather similar to the 6.17 average score observed for similar products.

"If you're trying to generate an attractive return in this particular type of structure, you can either take a stock like this one with a reasonably high volatility or you can take more underlying assets, use indexes and structure it as a worst of. What they've done here is the first option. But you get pretty similar return scores," she said.

The product received a 7.22 price score, suggesting good value for the investor.

With its price score, Future Value Consultants measures on a scale of zero to 10 the market value of the underlying components of the product as a percentage of the initial investment.

The score gives an estimate of the fees taken per annum. The higher the score, the lower the fees and the greater value offered to the investor.

In comparison, the 6.66 average price score for similar products was lower.

"This indicates that investors in this product get a good value for their money based on the market parameters," she said.

The price score and return score are averaged to obtain the overall score of the product, which represents Future Value Consultants' opinion on the quality of a deal.

Because this product shows a slightly lower return score than its peers while its price score is better, the overall score of 6.67 exceeds the 6.42 average for the products of the same category by only a small margin.

As a conclusion, Hampson said that investors need to be familiar with the stock and have a view on it before considering the notes.

"This is a product investors may look at in order to capture more yield. But it's not a fixed-income product given the market risk," she said.

"You don't have to be particularly bullish; all you need is a flattish market.

"But you have to consider the underlying. This is not the S&P 500. It's a stock, and if you're picking it, you have to know what you're dealing with, otherwise you could lose not just your coupon but your entire investment as well."

J.P. Morgan Securities LLC is the agent.

The notes will price Wednesday and settle April 30.

The Cusip number is 48125VVR8.

© 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.