Deutsche's autocallables on Russell 2000: elevated protection offsets long tenor, sources say

By Emma Trincal

New York, Dec. 13 - Deutsche Bank AG, London Branch's planned autocallable notes linked to the Russell 2000 index offer an unusually high level of downside protection that makes the notes attractive despite a long-dated maturity, financial advisers said.

Deutsche Bank plans to price 0% autocallable optimization securities with contingent return due Dec. 29, 2015 tied to the Russell small-cap benchmark, according to an FWP filing with the Securities and Exchange Commission.

If the index closes at or above its initial level on any of the quarterly observation dates, the notes will be called at par of $10 plus an annualized return of 8.25% to 10.75%. The exact call return will be set at pricing.

Solid protection

"It's not that often that you see a five-year term on an autocallable," said Carl Kunhardt, director of investment management and research at Quest Capital Management. "It's usually not longer than 18-month, three-year at the most."

But Kunhardt also noted the "unusually" protective barrier level that goes along with the maturity.

The payout at maturity will be par if the index finishes at or above 50% of the initial level.

If the index dips below the trigger level, investors will share fully in the decline from the initial level.

The 50% protection does not constitute a buffer, according to the prospectus, because investors can lose up to 100% of their principal.

But Kunhardt said that he was satisfied with the barrier.

"It's not a buffer. But for all intents and purposes, it is a buffer. I don't see any realistic scenario in which this 50% barrier could be breached," he said.

"You would need to lose 10% a year for five years, or you would have to get another 2008 at the end of the period.

"It's really a reasonable level of protection, and I may consider the notes because of this."

Eric Greschner, portfolio manager at Regatta Research & Money Management, said that he liked the protection as well, adding that he always evaluates the level of downside protection before even looking at the coupon.

"A 50% barrier is fairly substantial," he said.

He also considered the year 2008 as the illustration for the most recent bear market.

"I really think we wouldn't have dropped that much in 2008 if Lehman had not been allowed to fail. So 50% seems attractive to me."

Long tenor

However, the five-year tenor represents one of the drawbacks, said Kunhardt.

"I don't like the length," he said.

On the one hand, a longer-dated product increases the number of observation dates, which may raise the probability of a call, a positive outcome for the investor, he reasoned.

But on the other hand, if the notes are not called, investors have their investment locked in for a long period of time without a payout, he noted. In addition, since performance is linked to the equity market, in the absence of a call, investors are subject to market risk, albeit one greatly reduced by the barrier, he said.

"You're getting called when you're doing well," Kunhardt said.

"Usually, we buy structured notes as a substitute for fixed income. Here, we would be buying it as an equity substitute."

Kunhardt said that reinvestment risk, which is created when the call is triggered, was not a concern.

"I don't see reinvestment risk because your return is linked to equity. If it gets called, you're fine. You take your gains and move on," he said.

Another plus was the creditworthiness of the issuer.

"I like Deutsche Bank. We've used them a couple of times," said Kunhardt. "I do mostly Credit Suisse and Wells Fargo. But Deutsche Bank is a good name."

Overall, the advantages of the notes may offset its shortcomings.

"It's not an investment I would strongly like or dislike either way. I would consider it in certain circumstances," he said.

When asked which ones, Kunhardt said, "If a client wants small cap exposure with a little bit of risk-taking but also some downside protection in case the market turns south.

"After the 50% barrier is breached, you're fully in. But I'd be fully in if I did the ETF direct anyway."

Greschner said that there is always a way to reduce risk for the most risk-adverse investors.

"If there was an issue of the market dropping substantially, you can always hedge," he said.

The notes (Cusip 25154P675) are expected to price Dec. 22 and settle Dec. 31.

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

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