Advisers stunned at size of JPMorgan’s capped buffered leveraged notes on Dow, Russell

By Emma Trincal

New York, Jan. 3 – JPMorgan Chase Financial Co. LLC’s $45,000 of 0% capped buffered return enhanced notes due Jan. 4, 2024 linked to the lesser performing of the Dow Jones industrial average and the Russell 2000 index showed a small notional size that contrasted with the attractiveness of the trade, said two buysiders.

If each index finishes above its initial level, the payout at maturity will be par plus 150% of the least performing index’s return, subject to a maximum upside return of par plus 27.5%, according to a 424B2 filing with the Securities and Exchange Commission.

If the final level of the least performing index falls by up to 10%, the payout will be par.

If the final level of any index is less than its initial level by more than 10%, investors will lose 1% for every 1% that the worst performing index declines beyond 10%.

One off

Carl Kunhardt, wealth adviser at Quest Capital Management, was intrigued by the small size of the offering.

“That’s a private note. It’s also a very nice note,” he said.

“We use [a fintech platform], and for us, they always require a million [dollars] minimum. So, $45,000 is sort of odd.

“You could see someone asking for that. Perhaps an adviser and a client talking about what they want to do specifically in the portfolio and asking the bank to create the note for them.

“I doubt they made anything on it.”

Terms

The terms of the product were very attractive, according to this adviser.

“There’s nothing not to like about this note, other than the worst-of.

“You’re playing off large-cap against small-cap. The Dow is really not a good index for anything. It’s just got 30 stocks.

But whoever conceived the product “put together” a “very good note,” he said.

“It’s relatively short-term. The leverage gives you a nice potential return. There’s a decent downside protection feature...a 10% buffer.

“Finally, there is no call. We’re not going to tease you with a nice coupon and call you away in three months.

“I really like it.”

Credit risk

A market participant was also surprised by the notional amount.

“A few years ago, you couldn’t do anything less than $500,000. This is a terrific note. I’m surprised it’s only $45,000,” he said.

He looked at the creditworthiness of the bank first.

“It’s a short-term deal and JPMorgan is a quality issuer,” he said.

“I don’t know of a non-quality issuer nowadays, at least in the U.S. Credit risk used to be a big concern. But banks are in a pretty good shape right now,” he noted.

JPMorgan has the tightest credit default swap spreads among its peers. Its five-year CDS spreads are 47 basis points versus 50 bps for Bank of America, 56 bps for Citigroup and 63 bps for Goldman Sachs, according to Markit.

High cap

But the most impressive aspect of the structure was the elevated cap on a short duration, he said.

“Technically, this note is intermediate. For us, two-year is short-term,” he said.

“If you’re going to get an uncapped, you have to go much longer. This one has a cap. But a 27.5% cap is amazing.

“Normally we don’t see a buffer and leverage on a two-year note with a cap as high.”

The cap represents a compounded annual return of nearly 13%.

“My rule of thumb is to get at least a 10% return if I’m going to take equity-type of return,” he said.

“With 13%, I certainly meet my goal.

“And the 1.5x leverage makes it much easier to hit that cap.”

Outperformance

Investors would be able to “hit” the cap if the worst-performing index grew by 8.8% per year.

Many large asset managers such as Blackrock, JPMorgan and Vanguard have predicted U.S. equity returns in the high single digits per annum for the next 10 years, he said.

“They’re all calling for returns anywhere around 7% or 8%. So, this is in line with most long-term forecasts, although we’re dealing with a short-term horizon, which is much harder to predict,” he said.

For this market participant who tends to buy longer-dated notes, a two-year tenor was relatively short.

“If you went five years, you could perhaps get an uncapped. But for what you’re given, a 27.5% cap is pretty competitive,” he said.

Correlation

The two underlying indexes were “straightforward,” he noted.

“True, there’s no overlap between the Dow and the Russell 2000, which is not ideal in a worst-of. These two are not fishing in the same pond. But they’re still equities, and they’re going to rhyme. It’s not going to be a 99% correlation, but it’s going to be above 90%.”

The risk in worst-of is to see the underlying assets move in opposite directions as it increases the probabilities of losses.

“There’s a good chance that you’re not going to see one going up 20% and the other down 20%. It’s just not going to happen,” he said.

Downside protection

The 10% buffer was also an attractive item.

“It’s between the two and three-year terms that you have the greatest chances of taking on large losses, like 20% or 30%. To protect yourself against that, you could have a barrier, but it would have to be enormous barrier, something like 30% or more. The risk of the barrier would still be too high,” he said.

This market participant said he would not feel safe with a 30% barrier on a two-year.

“I’m much more comfortable with a 10% hard buffer,” he said.

Pricing

Perhaps what made the structure so appealing, he said, was the low cost of the product. The prospectus disclosed a 0.25% fee.

“This fee is extraordinary competitive, which is why the terms are so attractive. Usually, when the fee is high, the terms are not nearly as good.

The quality of the product contrasted with the size of the offering.

“With terms that good, you wonder why there was not more money behind it. $45 million would not surprise me. But $45,000? You would think they would want to open it to other people,” he said.

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes settled on Monday.

The Cusip is 48132Y5Y7.

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