JPMorgan’s $15.65 million digitals on S&P Banks Select Industry designed for income

By Emma Trincal

New York, Oct. 27 – JPMorgan Chase Financial Co. LLC’s $15.65 million of 0% digital equity notes due Nov. 20, 2024 linked to the S&P Banks Select Industry index could be used as income substitute for investors seeking yield in their portfolio, sources said.

The tenor of the note is short enough and the odds of receiving the equivalent of a coupon high enough to justify this categorization, they noted. But the risk remains significant as the return is not guaranteed and remains linked to the performance of a sector-based equity index.

If the index finishes at or above 70% of its initial level, the payout at maturity will be par plus 8.54%, according to a 424B2 filing with the Securities and Exchange Commission.

Otherwise, investors will lose 1.4286% for every 1% decline beyond 30%.

Sector in the red

“I would look at this note on the fixed-income side of things. You’re not trying to outperform the index. As income replacement, there is some appeal to this. But it comes with significant risk,” said Jeff Pietsch, founder of Capital Advisors 360.

Pietsch noted that the S&P Banks Select Industry index has underperformed.

“The index fell a lot this year. But it’s still well above the Covid lows,” he said.

The index on the trade date closed at $808 a share, down 19.2% for the year. But since its low of March 2020, the underlying has gained 40%.

“We have a de-inversion of the yield curve. It’s a plus for banks that make money on the long end of the curve rather than on the short end. Now they can generate a positive spread,” he said.

Volatility

But the risks of the trade are substantial, he noted.

“Banks have a significant exposure to real estate. There will be large tranches of refinancing coming up in 2024 and 2025, which will put some pressure on financial institutions.

“As the market demonstrated this year, this is a sector that can drop strongly and quickly,” he said.

Between mid-February and early May, the S&P Banks Select Industry index lost 37% of its value. The downturn was the result of the banking crisis, which hit the sector in March when two U.S. regional banks and Credit Suisse collapsed.

Pietsch said he was not comfortable with the gearing attached to the buffer.

“It bothers me a little. The odds of that breach happening are low. But it’s still a possibility,” he said.

Pietsch said he was not sure he would be willing to be exposed to the downside risk.

“The spread over Treasuries isn’t worth the complexity of the structure and the exposure to a very volatile sector.

“However, as part of an income strategy in a diversified portfolio, it’s a note that can make a lot of sense.

“You just have to understand the risk you’re taking,” he said.

Income

Scott Cramer, president of Cramer & Rauchegger, also viewed the note as a yield-enhancement product.

“Some may see it as a bearish bet, but I don’t see it like this at all. This is an income play. You’re buying the note for the income, not for growth. All you’re trying to do is earn that 8%. If you’re wrong, you have the 30% protection,” he said.

Cramer would have preferred to see a regular buffer.

“I hate geared buffers. But that’s just me. They didn’t ask me when they designed it,” he said.

He looked at the risk-adjusted return of the note, comparing its yield with the risk-free rate.

“You can get a one-year T-bill for a 5.4% yield. Is the note worth the extra 2.5% premium? Do you have enough protection?”

Risk still too high

The 8% return is guaranteed under a performance condition, which is for the index not to drop more than 30% at maturity. Therefore, risk analysis was key to determine the odds of a positive outcome, he explained.

“The banking sector is beat up. But they can have more pain. Those big banks have billions of real estate loans on their balance sheet and if we go through a recession, I’m not sure that 30% will be give you sufficient downside protection,” he said.

Other factors could favor the sector, for instance a steepening of the yield curve or the economy moving into soft landing mode.

“But you can’t predict those things,” he said.

“I like the prospect of getting my 8% even if the market is down 30%,” he said.

“That’s what you’re playing for. You either get it or you don’t.”

Cramer said he liked that type of “bet” given that the odds of getting paid were relatively high.

“But again, if this index goes down, it will go down. You’ll be paying for that.

“It is a good bet.

“The likelihood of winning is good.

“But is it worth the risk? I would probably look for something else,” he said.

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent. Simon Markets LLC is also named as a dealer.

The notes settled on Oct. 25.

The Cusip number is 48134BRH8.

The fee is 1.08%.

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