JPMorgan Chase, Goldman Sachs price worst-of issues featuring contingent coupon at maturity

By Emma Trincal

New York, Oct. 30 – JPMorgan Chase & Co. and Goldman Sachs Group, Inc. priced autocallable worst-of issues with the particularity of making a contingent payment at maturity even if the worst index finishes negative provided that it closes above a barrier, which is lower than the initial price. Sources called the feature of paying a “final coupon” somewhat unusual although not “unheard of.”

“It’s interesting. It’s different. Usually when you’re not called you either get the downside of the worst of or you get par. Here at the end you get a last coupon, not necessarily a chance to really catch up, but you get something. It’s not something I’ve not seen before, just a different way to price it,” a market participant said.

JPMorgan

The first deal is JPMorgan’s $5.85 million of 0% review notes due Oct. 29, 2018 linked to the lesser performing of the S&P 500 index and the Russell 2000 index with annual observation dates.

The notes will be called at par plus a premium of 8.85% per year if each index closes at or above its initial level on Nov. 3, 2015, Oct. 24, 2016, Oct. 24, 2017 or Oct. 24, 2018, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called and the final level of each index is less than its initial level by up to 30%, the payout at maturity will be par plus 8%. Otherwise, investors will lose 1% for each 1% that the lesser-performing index's final level is less than its initial level.

Attractive feature

“It’s a very attractive feature. The market is down, you’re not called. But you’re still collecting the 8% at the end up to a certain limit. It can be helpful if we go down through a bear cycle,” said Steve Doucette, financial adviser at Proctor Financial.

“We’re on the sixth year of a bull market. Historically, you get a bear market every five or six years. It’s nice to have an 8% at the end. The scary part is that things can get ugly; you breach the barrier and you’re long the worst of.”

Doucette said that deciding where to allocate the notes is key to assessing their value.

“How does it fit into the asset allocation? As a fixed-income replacement, you can see it as an 8% on four years, or 2% a year. Things would have to be pretty ugly before you reach that below-30 level. So if I hold it, I get par plus 8%,” he said.

“At the same time, you can also look at where we are in the market. It is not a bad equity substitute to have an 8.85% return. But it’s equity-linked. If you want to go in this in order to get called, you have to look at where we are in the market cycle and whether you want to accept this 30% barrier. If you do, you can just stay in there and earn an 8% and hope it doesn’t plunge at maturity. Getting a small coupon at the end is not bad.”

But Doucette said that he may be able to “find better terms” with other underliers.

“With different indexes or correlations, you may be able to lower the barrier and capture a higher coupon,” he said.

No memory at the end

The call premium can accumulate through a “lookback” when investors get called but have missed prior payments, the market participant noted, adding that such option is not available if the notes mature.

“This coupon they may pay at maturity, it’s really your last coupon they’re paying. You’re not getting double or triple as you would if you were called,” he said.

The structure indeed offers a feature sometimes referred to as “memory.” If the notes are not called on the first review date, investors will recoup it upon the second call with a 17.70% premium. The premium would rise to 26.55% on the third year and to 35.40% at maturity, according to the prospectus.

“The final contingent payment offers no catching up. It’s 108%. You just get a last coupon when you fail to be called on year one, year two, year three,” he said.

However, he noted that the final coupon does not require the index to be above par.

“It simply has to be down by less than 30%,” he said.

“Like all those autocalls, of course you want to get called. That’s the game. But if you don’t, then at least you can have the last year.

“On the other hand, you still get pretty much the downside below 30%. That’s the game too.”

Longer-dated worst-of

The second offering, brought to market by Goldman Sachs, introduces another barrier on the downside, creating more payout scenarios. The observation dates are quarterly. The notes are not autocallables but callable at the issuer’s discretion with one year of call protection. The greatest singularity, sources said, is that the worst-of has a long duration and pay a fixed rate for the first four years.

Goldman Sachs priced $1.66 million of callable contingent coupon notes due Nov. 7, 2029 linked to the Russell 2000 and the Euro Stoxx 50 index, according to a 424B2 filing with the SEC.

The notes pay a fixed coupon of 1.875% per quarter, or 7.5% per year, until November 2018. After that, the notes pay a contingent quarterly coupon at an annual rate of 7.5% if each index closes at or above its 70% trigger level on any quarterly observation date.

The notes are callable at par plus the contingent coupon on any quarterly call date beginning in November 2015.

If the notes are not called, the payout at maturity will be par plus the contingent coupon if both indexes finish at or above the 70% trigger level. If both indexes finish at or above negative 50% but the return of either index is less than negative 30%, the payout at maturity will be par. If either index falls by more than 50%, investors will share in the losses of the lesser-performing index.

“I would never speculate where the market is going to be in 15 years. It blows me away that you could,” Doucette said.

“They pay you a coupon for four years. That’s good. I still don’t know why you would do that. It’s a 15-year equity note.

“I would think you would have some liquidity. Goldman probably makes a market and you can trade in and out. But what price do you get?”

Doucette said the contingent coupon, which could be collected quarterly, is a good feature.

“You get paid as you move along; you can clip the coupon each quarter. There is no autocall. But they can call you anytime except for the first year. So that’s something to look at,” he said.

“If you get to maturity, you get the final coupon. I don’t think it cost a whole lot though.”

Doucette said he would rather give up the coupon at the end and lower the barrier in order to secure more protection.

“I think I would be happier with that,” he said.

The market participant said he saw limited appeal in the long duration for this type of structure and underlying asset class.

“So you definitely win for four years. Yet you’re risking 11 years of coupon,” he said.

“Like most deals, they give you some protection but you sell the upside. It’s a 50% protection. I’m not saying they’re ripping people off. If they didn’t price it correctly, people would not buy it. But you still have equity risk with limited upside on a long-term note that’s callable on a discretionary basis. Look, it’s just strange to see a worst-of on a 15-year.”

Pricing twist

Tim Mortimer, managing director at Future Value Consultants, underlined the similarities between the two offerings.

“Whether it’s a callable or an autocall, there is a final contingent coupon. They’re trying to show some return in a falling market,” he said.

Talking about the first deal, he said, “The reason they’re doing it is that the chances of finishing up above 70 if you haven’t been called or autocalled before are slim. You would probably expect one of the two indexes to be below 70 after four years. It’s only 8% anyway.”

The full call potential is 35.4%, he noted.

“If you get the last payment, if you’re not called, you’re only getting a quarter of that. Even if you get it at a lower threshold, the chances of being in that 70 to 100 range at that point in time are limited.”

About the Goldman Sachs deal, Mortimer played down the difference between a call and an autocallable feature.

“It’s about the same. If it moves, you’ll get called. The issuer has the discretion, but in reality it’s quite similar. The levels may be different, but it’s the same principle,” he said.

“If rates or volatility move a lot, they might call for that reason. But it’s mostly driven by the moves in the index prices.”

He summarized the structure, saying that “if you’re below 50%, you get the worst of. If it’s down between 30 and 50, you get your principal back. If it’s greater than 30%, you get the coupon, the last coupon, but it’s the quarterly coupon. I’ve seen those things before, although it’s not the most common way to do that type of structure. It’s a different way to spend the money on the coupon, instead of the protection.”

Both offerings priced Oct. 24.

J.P. Morgan Securities LLC was the agent for the JPMorgan deal (Cusip: 48127DE95). The fee was 2.15%

Goldman Sachs & Co. was the underwriter for the Goldman Sachs deal (Cusip: 38147QK54). The fee was 5.05%.

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