Advisers baffled by $38.8 million bid on Deutsche's notes tied to Dow Jones-UBS Commodity index

By Emma Trincal

New York, Dec. 17 - Deutsche Bank AG, London Branch's $38.8 million of securities due Jan. 29, 2014 linked to the Dow Jones - UBS Commodity Index Total Return puzzled financial advisers, who said they did not understand why the structure would warrant the high bid. The absence of any downside protection combined with three times leverage on the downside and a complex fee structure made it difficult for them to feel upbeat about the product.

"The sheer volume of the issuance is amazing. This is a big, big thing. And yet, I'm at a loss as of to what's in it for me or my clients here?" a financial adviser said.

"People who would buy this would have to be bullish on the index. You think you'll make three times the upside. You're all in. And that's how you lose your shirt," said Carl Kunhardt, wealth adviser with Quest Capital Management.

But Michael Johnston, founder and senior analyst of ETF Database, said that investors might have had a good reason to bid on the notes.

"There's just no ETF on the Dow Jones - UBS Commodity index that gives you a three-times leveraged exposure. It doesn't exist. That could explain why people liked it," he said.

Another factor may be the scarce supply of commodities-linked notes, which have consistently declined in volume and percentage shares since September, according to data compiled by Prospect News.

While those products amounted to $452 million in September, their volume dropped steadily to $304 million the next month, down to $205 million in November and to finally $104 million this month to date.

But looking at the structure only, advisers said that they did not like the payout and the complexity of the terms.

Interest equals one-month Libor minus 16 basis points and is payable monthly, according to a 424B2 filing with the Securities and Exchange Commission. The coupon rate for the initial month will be 0.04900%, according to the prospectus.

The notes are putable at any time, and they will be called if the index declines by 15% or more. Holders who put back less than all of their notes must put back their notes in integral multiples of the face amount.

The payout upon redemption or at maturity will be par plus triple the sum of the index return minus some fees defined according to a formula based on the T-Bill and an adjustment factor.

Not for me

"I wouldn't go near the notes with a 10-foot pole," said Kunhardt. "Everything that I dislike in structured products is there.

"Number one [is] complexity. If it takes five-minutes to describe it, it's just too complicated. I'm not interested.

"Two, it's got leverage, and I don't like leverage up or down. It's just the planner in me."

"Number three, I'm totally exposed on the downside. I can do that with a regular investment. Why using a structured product?

"Four, it enhances my return, but I don't use structured products just for the upside. I have to mitigate the risk. This note doesn't do that.

"The fee is high for what I get," he said.

Finally, looking at the coupon, which based on the first period rate of 0.049%, would be 0.6% assuming Libor stays the same, Kunhardt said that: "They may save themselves time for the interests that won't incite anybody."

Please, no 3X down!

Advisers are not used to see leveraged notes that feature symmetrical leverage on the upside and on the downside, the financial adviser said.

"Almost all structured notes parameters provide ways to reduce risk in leveraged notes, for instance no leverage on the downside, only on the upside or some kind of a floor with a buffer. None of this is here," he said.

"Nothing here is giving me what I want. A structured note to me is all about downside protection. This one, not only doesn't give me any downside protection, it actually gives me three times the downside performance. Wow!"

Negative aspects of the structure offset some more positive terms, they said.

For instance, advisers liked the put, always favorable to investors who exercise the option at their discretion. But on the other hand, the issuer would redeem the notes if the index price closed down 15%.

Call and put

"The call is another problem. They lock in your losses and you have no opportunity to get it back. Thank you, goodbye," said Kunhardt.

"I can't see anything in the notes to like."

"The put is obviously a nice benefit. If the index is up 10%, you are up 30%. You put it to the issuer, take the money and run, which is great," the financial adviser said.

"But I don't want the issuer to call away the notes from me. The way it's set up, I can't ride it out.

"The put adds liquidity but that's not enough to offset all the negative aspects of the structure," he said.

One positive term was the issuer's credit risk however.

"The underwriter is Deutsche Bank. It's pretty solid. I have no issue here," this adviser said.

Complexity

Besides the lack of downside protection, the negative leverage and the call feature, those sources said they did not like the complexity of the fee structure.

The payment at maturity or upon any early redemption will be reduced by about 0.60% per year due to a 0.20% adjustment factor per annum being applied on a three-times leveraged basis. In addition, the redemption amount is subject to the deduction of the T-Bill Return on a three-times leveraged basis, according to the prospectus.

"This is very confusing. The whole interest payment, I can sum it up looking at their prospectus. If your index finishes flat, you lose 8.17%. You have to subtract three-times the T-bill and three times the adjustment factor. There are too many brackets to define the fees, the coupon. It's just so complicated," the financial adviser said.

He was referring to a page in the prospectus featuring a hypothetical redemption amount table. The prospectus table was based on a hypothetical T-Bill Return of 2.50%, which on a three-times leveraged basis and combined with the leveraged adjustment factor would generate the 8.1% loss.

"Maybe an institution did it, attracted by the put option or for hedging purposes. I don't see how any adviser would want to show that to a retail or high-net-worth client. It's unbelievably confusing and dangerous," he said.

The notes (Cusip: 25152RAS2) priced on Wednesday.

Deutsche Bank Securities Inc. and Deutsche Bank Trust Co. Americas were the agents.

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