Deutsche Bank’s Stars linked to three financial stocks offer high call premium, no barrier

By Emma Trincal

New York, April 15 – Deutsche Bank AG, London Branch’s 0% Strategic Accelerated Redemption Securities due April 2018 linked to the worst performing of the common stocks of Citigroup Inc., JPMorgan Chase & Co. and Wells Fargo & Co. offer a high potential upside for investors who agree to get paid only when the notes are called.

The lack of any coupon barrier or principal barrier, the worst-of payout and the frequency of the observation dates are additional risk factors, which contribute to enhance the yield as well, they noted.

The notes will be called at par of $10 plus a call premium of 20% to 25% per year if each stock closes at or above its initial share price on any annual call observation date, according to an FWP filing with the Securities and Exchange Commission. The exact call premium will be set at pricing.

If the notes are not called, the payout at maturity will be par minus 1% for every 1% that the worst-performing stock finishes below its initial share price.

“The autocall is there to enhance the yield. In this you have a 20% to 25% call premium, and it’s a high premium,” a sellsider said.

Observation

“We mostly do semiannual or quarterly observation dates. You get more premium when it’s annually,” he said.

“What we also tend to do is place a 95% or 90% autocall level so that the probability of getting called is higher. That’s what our clients wish. They want to get out of the risk as soon as possible but still have some yield.”

The most common autocallable trigger level, however, is equal to rather than below the initial price, as it is the case with the Deutsche Bank structure, according to data compiled by Prospect News.

One single strike

Setting the coupon barrier at a higher level than the usual coupon barrier, which is typically lower than the call trigger, allows the issuer to maximize the coupon, he explained.

“By placing the contingency at 100, you increase the risk of not receiving any coupon. If the underlying is not above its initial level of 100, you don’t get paid and you don’t get called. The worst-case scenario: you don’t get anything,” he said.

“There is more risk in this structure. You must have a bullish case.”

Correlation

Correlation, however, provides some risk reduction.

“Those three stocks are fairly correlated,” he said.

“I don’t mind having three stocks in the same sector. It eases the management of your portfolio because you can manage the risk better.

“If you had Exxon, Intel and Gilead, you’d get a much higher coupon. The correlation would be much lower. The volatility would be much higher.”

But in this deal, the high correlation helps mitigate some of the risk, he said.

No barrier

An industry source also pointed to the risk of loss of principal.

“It’s interesting that there’s no barrier. No barrier at all. No coupon barrier. No barrier for the principal repayment,” this source said.

“It’s a totally bullish trade. It’s bullish on financials and probably bullish on the economy. You believe that interest rates are going to rise.”

The use of three financial stocks is not new, he noted.

“Bank stocks deals have been done. Sometimes it’s been done on more diversified baskets of financial stocks. But this is not the first time someone used financials stocks on a worst of,” he said.

Growth

Because the structure offers no fixed or even contingent coupon, this source said he views the notes as a growth rather than income product.

“It’s distributed by Merrill Lynch. Their advisers must have a very distinct view on financials,” he said.

“It’s more of a growth idea. This note pays no income. You get paid if the notes are called. If you wanted income, you would be looking at some other kind of product, more like a phoenix.”

Phoenix autocallable notes have two types of barriers or strikes: a coupon barrier usually set at the lower level and the call threshold often set at par. Investors in those products may collect the contingent coupon during several pay periods without getting called.

“Contingency autocallable notes let you earn the coupon at a lower barrier. Here, if the stock doesn’t get above 100, you don’t get any income,” he said.

“This product obviously pays a pretty high coupon. The obvious reason is the absence of any barrier.

“Without the early redemption, you don’t get paid and your entire principal is then at risk.”

BofA Merrill Lynch is the agent.

The notes will price and settle in April.

© 2015 Prospect News.
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