Deutsche's notes on S&P MidCap, SmallCap offer high protection, little leverage on long tenor

By Emma Trincal

New York, Nov. 3 - Deutsche Bank AG, London Branch's upcoming performance securities linked to a basket of U.S. equity indexes caught the attention of market participants for their large buffer, low leverage and long tenor.

Deutsche Bank plans to price 0% performance securities with contingent protection due Nov. 30, 2015 linked to the S&P MidCap 400 index with an 80% weight and the S&P SmallCap 600 index with a 20% weight, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 100% to 110% of any index basket gain, with the exact participation rate to be set at pricing. Investors will receive par if the basket declines by 40% or less and will share in all losses if it declines beyond 40%.

Conservative buffer

Charlie O'Flaherty, principal at Third Reef Holdings, said that he liked the buffer.

"I think they'll do well. The 40% buffer is pretty conservative.

"It's a five-year. For sure, they had to go that far to get that kind of a buffer.

"Even on a five-year, losing 40% would be pretty disastrous. Anything is possible of course, but I wouldn't feel bad about buying this."

Extending the maturity to five years was one way for the issuer to pay for the unusually protective buffer, he said. Another was to use less, if any, leverage.

"The low level of leverage is part of it. You don't get that type of downside protection with huge leverage. The participation rate is going to be anywhere between 100% and 110%. Still, getting 100% of the upside is not the worst thing that can happen to you considering a 40% buffer."

Cautiously bullish

Tom Livingston, director of structured products at Halliday Financial Group, said that the notes could be a "good deal" but that it "depends on your view."

"It's not a bad idea as long as your view is bullish," he said.

Investors with no cap and limited leverage, as with this note, would in theory need to be "very bullish," he noted. The moderately bullish investor tends to prefer a note with more leverage and a cap, he explained.

Yet, someone could be at the same time "very bullish" and "cautious," he said, which explains the appeal of the 40% buffer for this category of investors.

"It really depends on who you are. If you want to participate in the small and mid-cap markets in a meaningful way but still want to take a cautionary approach, then it's probably not a bad deal."

The 80/20 mix

The notes are "suitable" for investors who want to participate in the performance of the S&P MidCap 400 index and the S&P SmallCap 600 index rather than getting paid a coupon, according to the prospectus.

But sources were not sure how to interpret the 80% allocation to mid-cap stocks and 20% to small-cap stocks.

While some said that the basket may reflect the way financial advisers interested in the notes would choose to allocate their clients' money between small-cap and mid-cap stocks, others suggested that the 80%-20% weighting was instead the result of pricing factors.

"I suspect the 80/20 was more of a function of where they priced the options rather than something based on an allocation model," said Livingston.

The notes (Cusip: 25154P501) are expected to price on Nov. 24 and settle on Nov. 30.

UBS Financial Services Inc. and Deutsche Bank Securities Inc. are the agents.

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