Deutsche Bank’s $10 million leveraged notes linked to Euro Stoxx have 5x leverage, ‘sweet’ cap

By Emma Trincal

New York, Sept. 10 – Deutsche Bank AG, London Branch’s $10 million of 0% capped return enhanced notes due Sept. 10, 2019 linked to the Euro Stoxx 50 index offer high upside participation with an attractive cap, a buysider said. In exchange, investors are fully exposed to the downside and earn no dividends on a high-yielding index, another source said.

The payout at maturity is par plus five times any gain in the index, up to a maximum return of 110.5%, or $2,105 per $1,000 principal amount of notes. Investors will be exposed to any losses on a one-to-one basis, according to a 424B2 filing with the Securities and Exchange Commission.

The final index level will be the average of the closing index levels on the five trading days ending Sept. 5, 2019.

Sweet cap

Andrew Valentine Pool, main trader at Regatta Research & Money Management, noticed at first the absence of any buffer or barrier.

“I like leverage, but I like protection too,” he said.

Yet he found the payout compelling enough to offset the downside risk.

“This note gives you five times leverage with a 110% cap. It’s an average of 20% a year. There’s no downside protection, but the cap is pretty sweet. Getting 110% on a five year ... Not bad! I’d be interested in looking at it. With so much leverage, the Euro Stoxx doesn’t need to go up that much, just about 4% a year,” he said.

Bulls would have to consider the upside risk, he said.

“You’re taking a chance. You’re willing to bet that you won’t hit the cap after five years. I’d be willing to take the bet as long as I put this note in the risk portion of the portfolio,” he said.

“The cap is sufficiently high. ... I’d be willing to take less return for something like five times the upside at that cap level.”

He offered an example: “Let’s just say Europe is up 40% five years from now. If you leveraged up a long-only position five times, you would get 200%. The buyer of the notes would have 110%. Would they be terribly upset? I don’t think so. You could tell this client, ‘yes we missed some of the upside, but we’re still up 110%.’ I don’t think I would lose that client.”

Cash management tool

Pool said that he often uses leverage as a tool not only to magnify returns but also to free up cash. With a small allocation, an investor gets five times the exposure, he explained, while the rest of the investor’s capital may be used for other investments, including hedges that help reduce the risk associated with leverage.

“Leverage frees up your capital so you can do other things. This note only locks up a portion of your portfolio. If you allocate $10 million, you get a $50 million exposure. There’s no reason why we can’t buy ETFs, ETNs or European stocks that we think give a broad-based exposure to Europe and that we do have control over. And we do that,” he said.

“If the European market reverses and we own the iShares Italy fund for instance, we can always get out. If Europe goes through a correction, we can short Europe to balance out this note’s long exposure.

“Generally we like downside protection, but you can make a good deal of money with the terms of this product.

“When it comes to downside risk, we’re more concerned with single stocks. We don’t do reverse exchange convertibles anymore because you can always have a CEO caught with his hand in the cookie jar.

“I would be interested to find more about this deal, especially if the pullback that everyone is talking about does happen. If the market goes down, I want even more.”

Squeezing the yield

Jack Ablin, chief investment officer at BMO Private Bank, noted a negative aspect of the notes aside from the lack of downside protection.

“That’s an interesting structure, obviously for those investors who are moderately bullish,” Ablin said.

“However, the structured note holders are not getting the dividend, which is a sizeable portion of the Euro Stoxx’s total return.”

The dividend yield on the Euro Stoxx 50 over the last 12 months is 3.17%.

“But they’ve been raising the dividend. The one-year dividend growth is 9.5%. They paid 80 cents in June of last year and 92 cents last June. It looks like this year the yield could be over 5% based on the current trend,” he said.

“That’s how you can get the five times leverage on the upside. They’re using the dividends to pay for the calls, and of course they’re using the cap too.

“You’re giving up a fair amount of the upside if the market moves sideways, perhaps 20% to 25% of the return just by foregoing the dividend.”

The notes (Cusip: 25152RPW7) priced Sept. 5.

J.P. Morgan Securities LLC and JPMorgan Chase Bank, NA were the placement agents.

The fee was 3%.

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