Deutsche Bank's two leveraged products linked to S&P 500 tap into different risk profile types

By Emma Trincal

New York, Sept. 4 - Deutsche Bank AG, London Branch announced two leveraged capped notes linked to the S&P 500 index, one with a buffer, the other without.

Investors like the idea of enhanced growth, but they value downside protection differently based on their market outlook, risk tolerance and the price in terms of features one has to pay to get the protection, sources said. Issuers therefore often come up with different versions of a leveraged note, with and without downside protection, in order to satisfy different market interests, sources said.

Deutsche Bank plans to price 0% return optimization securities due Oct. 18, 2013 linked to the S&P 500. The 13-month notes give investors at maturity par of $10 plus triple any gain in the index, up to a maximum return of 14.5% to 17.5% that will be set at pricing. Investors will be exposed to any losses, according to an FWP filing with the Securities and Exchange Commission.

The second offering is Deutsche Bank's 0% buffered return optimization securities due Sept. 30, 2014 linked to the S&P 500. This product is longer in duration with a two-year maturity. It offers only two times leverage on the upside instead of three, but investors benefit from a 10% buffer on the downside. The maximum return will be 18.5% to 23.5%, with the exact cap to be set at pricing. Investors will receive par if the index falls by up to 10% and will lose 1% for every 1% decline beyond 10%.

Sources assumed a midpoint maximum return, or a cap of 16% for the first deal, which on a 13-month note would be the equivalent of a 14.75% return per annum. Based on the same assumption, the second deal would offer a 21% maximum return, or a 10.5% annualized return.

Buffered preferred

"You would think the first one is more bullish, but in reality it's more of muddle," said Donald McCoy, financial adviser at Planners Financial Services.

"The S&P can't drop that much and can't be up that much. It's neither very bullish nor very bearish. You do have three times leverage on the upside and one time leverage on the downside. From a loss perspective, you're taking some market risk," he said.

But the positive aspect of the deal is the upside potential.

"You can get a good return fairly easily. You look at a 5% return to get 15%, and you're only in for a year," he added.

"With the other one, you're in for two years and your annual cap at 10.5% is lower."

He noted that with the second product, investors may have a better outlook on the market given that they agree to take on less leverage while still betting on a double-digit return.

"You're in for a longer period of time, and you have given up some of the upside. You're doing it for the downside protection. With the buffer, you can keep a good chunk of the loss the S&P may suffer," he said.

"The more conservative investor is going to want the second one, of course. But the protection has a cost, and you pay for it with a lower cap and a longer term."

If given the choice, McCoy said that he probably would choose the second deal, the buffered notes.

"I just see some inherent risks in the market. We are starting at a point where the S&P has seen significant gains. Depending on your outlook, you could say that the market is fairly valued or overvalued.

"If you revert to the mean over the next two years, you can see the potential for a significant drop. A lot of it will depend on the economic picture in China and the development of the European crisis. If the European stagnation pushes down the growth rate in China, the impact on the markets could be significant. A lot of people could become risk averse," he said.

Even though a 10% buffer for two years may not seem like a lot, McCoy said that it could make a difference.

"If you're down 12%, you only lose 2%. Of course if the market was down 40%, losing 30% would not be so much of a consolation. But if the losses are not catastrophic, the buffer is definitely attractive. It's a way to outperform the benchmark even in a down market," he said.

Short play

Dean Zayed, chief executive officer at Brookstone Capital Management, said he is willing to take the downside risk for a potentially more rewarding payout.

"I'm not giving up a big buffer. It's only a 10% buffer on two years," he said.

"A lot of people think that 2013 could be a downside year. I'm not sure that the 10% helps that much this type of pessimistic investor.

"I tend to see the market slightly up, in a relatively narrow trading range, but up in the single digits over the next 13 months.

"By getting three times the market return, you can do pretty well."

Zayed said that the downside risk is relatively small in his mind because he doesn't expect a lot of volatility looking forward.

"I don't see the market down a lot or up a lot," he said.

"It's a short duration. The market moved fairly much this year.

"With that three times leverage, you are relatively bullish but not extremely bullish. You don't believe that the market will be up substantially in the next 13 months, unless there's another QE3 and we get a big move out of it.

"I think it's a safe bet. You see the market somewhat in a trading range. If it trades slightly up, the three times leverage will pay out nicely."

The 13-month notes (Cusip: 25154V151) will price Sept. 14 and settle Sept. 19.

The two-year buffered notes (Cusip: 25154V177) will price Sept. 25 and settle Sept. 28.

UBS Financial Services Inc. and Deutsche Bank Securities Inc. are the agents for both products.

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