JPMorgan’s $30.51 million contingent income notes tied to indexes have hard-to-get, high gain

By Emma Trincal

New York, May 25 – A subsidiary of JPMorgan Chase & Co. issued last week a high-paying contingent coupon deal, but the probabilities of getting fully paid are considered by sources to be slim.

JPMorgan Chase Financial Co. LLC priced $30.51 million of contingent income callable securities due May 24, 2018 linked to the worst performing of the Euro Stoxx 50 index, the Russell 2000 index and the S&P 500 index, according to a 424B2 filing with the Securities and Exchange Commission.

The notes are guaranteed by JPMorgan.

Each quarter, the notes pay a contingent coupon at an annual rate of 15.1% if each index closes at or above its downside threshold level, 75% of its initial index level, on each day during that quarter.

The notes are callable at par on any quarterly determination date other than the final one.

If each index finishes at or above its downside threshold level, the payout at maturity will be par plus the final contingent coupon. If the final level of any index is less than its downside threshold level, investors will be fully exposed to the decline of the least-performing index.

The 15.1% annualized coupon over a period as short as two years is very high, sources said. It reflects the risk of not being able to collect it.

Any day observation

Mark Dueholm, chief trader at Landolt Securities, pointed to the “American” coupon barrier, a specific feature in the contingency that increases the difficulty of receiving the 15.1% return.

“I haven’t seen that before. It’s pretty unusual,” he said.

A barrier is said to be “American” when it is observed over repeated observations dates. In this case, the barrier can be breached on any trading day. Inversely, a so-called “European” and much less risky barrier will be observed point-to-point, usually at maturity.

If any of the three indexes just once breaches the 75% threshold on any trading day during the quarter, investors lose the opportunity to collect their coupon for that quarter, he explained.

“The reason they give such a high coupon is because they only pay you if there is no breach. None of the three indexes can hit the barrier on any given day,” he said.

The risk of not receiving the coupon is compounded by the worst-of structure itself.

Risks

“They only look at the worst of the three, and you have three indexes, not two,” he said.

“Then you have the everyday contingency.

“Finally, there is the risk of being called at the discretion of the issuer.”

So while a 15.1% annualized return is high, it takes a lot to be able to receive it, he noted.

The downside appears to present some risks, he added.

While observed at maturity and not – unlike the coupon barrier –“any day,” the 25% contingent protection amount is not sufficient, in his view.

“I don’t like the 75% because it’s such a short-term note. The longer you go out, the less likely it is that you would breach the barrier,” he said.

“If we have a 25% correction, I don’t think it’s going to last very long.”

Yet investors may still be caught in the downturn two years from now.

“If it was longer, I could live with the 25% protection ... but not on a two-year.

“It’s a big coupon, but there is a reason for that.”

Low probabilities

Investors who bought the notes were probably comfortable with the probabilities of return outcome, said a market participant.

“Look, it’s not impossible, but it’s very unlikely that you’ll get the coupon. It’s more likely that you’ll get called,” he said.

But investment decisions are often the result of limited alternatives, he added.

“Putting your money in a money market fund will give you 0.5%. That’s a sure thing. If you want 1% you take on a tiny bit more risk, and so on and so forth. You always have a choice,” he said.

“From that perspective, this deal gives you a very low probability, but if it does happen, then you get 15%.”

The three underlying indexes are not in place to enable investors to express a view.

“I wouldn’t say people bought it to express a view on those three markets. They bought it for the coupon,” he said.

“There is a decent correlation between the three indexes but enough of non-correlation to generate a high coupon.

“There are many bells and whistles in this note. And that’s also something you’re getting compensated for.”

The notes (Cusip: 46646EDE9) priced on May 20.

J.P. Morgan Securities LLC was the agent.

Distribution was through Morgan Stanley Wealth Management.

The fee was 2%.

© 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.