Deutsche Bank prices $129 million Accelerated Return Notes on S&P, year's No. 4 deal so far

By Emma Trincal

New York April 2 - BofA Merrill Lynch priced the No. 4 deal of the year so far on the behalf of Deutsche Bank AG, London Branch, a $129.19 million issue of 0% Accelerated Return Notes due May 29, 2015 linked to the S&P 500 index.

The payout at maturity will be par of $10 plus triple any index gain, up to a maximum return of 10.89%. Investors are exposed to any losses, according to a 424B2 filing with the Securities and Exchange Commission.

Top deals

The largest deal so far this year was Credit Suisse AG, London Branch's $225.9 million return notes linked to the upside return of an equally weighted basket of three Select Sector indexes and the downside return of the S&P 500 index. The notes were priced in early February by J.P. Morgan Securities LLC. The basket consisted of the Select Sector Technology index, the Select Sector Financials index and the Select Sector Industrials index.

The second largest offering was Bank of Montreal's $168.86 million of 0% senior medium-term notes, series B, due Jan. 28, 2015 linked to Raymond James Analysts' Best Picks for 2014, which priced in January at 102.75 for $173.5 million of proceeds.

The No. 3 deal was another JPMorgan product, similar to the Credit Suisse offering. It was Goldman Sachs Group, Inc.'s $169.52 million of 0% relative performance notes due March 4, 2015 linked to the performance of the S&P 500 index and a basket of the same three Select Sector indexes.

Sources said that last week's offering - characterized by high upside leverage, the absence of downside protection and a relatively attractive cap - was popular in part due to the market view it expresses.

Mild bulls

"If your view is that we'll have a fairly normal equity market for 2014, this deal has the potential to outperform the benchmark. Say the market is up only 4%, the three-times up will take you to the cap," a market participant said.

"Many among market strategists point to a market that should be positive in 2014 but not like in 2013. In that regard, a note like that makes sense."

An industry source said the strong bid had a lot to do with the 14-month maturity.

"The appeal is the short term," this source said.

"We're doing longer-term stuff, but those shorter-dated products have a lot of appeal."

No complexity

The structure was also seen as attractive due to its simplicity.

"Some deals appear amazingly attractive, but you always have to ask yourself how it gets priced," the market participant said.

"Some steepeners on the rate side look attractive, but most investors have no idea how they get priced and what secondary market pricing looks like.

"It's true with commodities-linked notes as well. A lot of times, you'll get a short-term note with some great leverage, no cap and a decent barrier for the protection, but you have to look at the underlying. If it's a basket of commodities for instance, chances are that one, two or more of those commodities are heavily backwardated - that's how the issuer can price it with such good terms. They can hedge it at a much cheaper price on the futures market.

"When you have a structure as simple as the S&P, three-times up, a cap and no protection, it's much more transparent, much more liquid. People can easily understand it."

Trading vehicles

While the short duration of the notes was seen as a significant factor behind the success of the deal, some questioned the benefits of short-term investments.

"That structure, the leveraged upside with no downside protection on a very short period of time ... we get that feedback from our capital market group. People like it. It's been the biggest selling structure in the market for some time. I'm not really sure why that is," the market participant said.

"To me, these very short-term notes would appeal more to a trader than an investor.

"It gives you the opportunity to outperform the market on a short period of time. If you go seven months through it and the underlying is up, there's still a chance if you decide to sell at that point to see some outperformance.

"So I get why it would appeal more to traders or short-term investors.

"But when you're selling notes to a retail platform, our view is that these products should not be used as trading tools but rather as a percentage of your core equity exposure. For that reason, we prefer longer-dated notes that offer more downside protection.

"Also, we don't see how much value you're getting from a 14-month deal, three-times leveraged and capped based on the S&P with no downside protection versus buying call spreads on the S&P.

"That's basically three call spreads and a short at-the-money put inside that trade. It's pretty simple, and you may not need a note to do that."

Going longer

Investors may like short tenors, but they have grown more accustomed to longer maturities, said the industry source.

"You'll have those short-term best-selling deals. But in general, I see a pickup in demand for longer-term notes," this source said.

"Investors are already comfortable with the longer contingent income notes. They are now getting more comfortable with longer products using some form of leverage or another.

"For instance, we see more of the five- to 10-year notes with leverage or a big jump or a longer-dated twin win, products which investors would have been uncomfortable with a couple of years ago."

The search for protection

The market participant agreed.

"Longer-dated notes have become more acceptable when they can provide some downside protection," he said.

"The way we highlight structured notes is by telling our clients that we're at all times high and that's great, but with equities up 30% last year and bonds having done not so great in 2013, there is a good chance that your asset allocation is out of balance.

"Equities have outperformed and bonds underperformed. In theory, you should sell some of your equity positions and move it into fixed income. But who wants to do that when bonds are artificially priced by central bank decisions and more volatile than they have been historically?

"The answer is not to move from equity to fixed income. Instead, you keep your exposure to equities but you simply change the way you get the exposure by buying structured notes with downside protection.

"And one of the easiest way to do this without limiting your upside too much is by extending the maturity. Investors are increasingly willing to do that."

The notes (Cusip: 25155P393) priced March 27.

The fee was 2%.

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