UBS to sell two 10-year leveraged notes with low barrier, no cap, but term seen as ‘long time’

By Emma Trincal

New York, Sept. 23 – UBS Financial Services Inc. is pricing two offerings of 10-year trigger performance notes, one issued by UBS AG, London Branch and the other on the behalf of Deutsche Bank AG, London Branch.

Each offering is linked to a separate equity benchmark, but they offer very similar terms such as solid downside protection and high potential for gains, according to advisers.

However, the long duration necessary to price those terms limits the appeal of the notes and thins the ranks of potential buyers, they added.

Two offerings

Deutsche Bank’s 0% trigger performance securities due Sept. 27, 2024 linked to the S&P 500 index have 1.59 times leverage on the upside, according to an FWP filing with the Securities and Exchange Commission.

If the index finishes at or above the trigger level, 50% of the initial level, but at or below the initial level, the payout will be par.

If the index finishes below the trigger level, investors will be fully exposed to the index’s decline.

Separately, UBS plans to price 0% trigger performance securities due Sept. 27, 2024 linked to the Euro Stoxx 50 index, according to an FWP filing with the SEC.

The payout at maturity provides a higher leverage factor of 2.16 times applied to any index gain. The 50% final barrier is the same.

Dean Zayed, chief executive of Brookstone Capital Management LLC, said that the terms of the notes are good but that the tenor makes the products desirable for only a few investors.

“The substantial leverage and 50% barrier are very impressive,” Zayed said.

“The issue I have –and most clients as well – is the 10-year term as well as the point-to-point interest crediting structure.”

Credit risk is not the main issue, he said.

“As 2008 and Lehman Brothers fades into our collective memories, most clients are less concerned with credit risk and more concerned with terms and competitiveness of product,” he said.

Timing

The length of the notes makes it difficult for investors to have a view on the market.

“Markets move fast, and information is instant today with thousands of talking heads out there discussing every minute and every movement of the market. To wait 10 years to know how a product will perform simply seems like an eternity nowadays, irrespective of the attractiveness of the terms,” he said.

“Add to this the fact that boomers and seniors often seek income from their portfolios, something these products do not offer.”

Some investors, however, may still benefit from the notes.

The type of client these products would appeal to would be “younger, growth-oriented clients” who have “no need for income and no need to use the money for 10 years,” he said.

But the entry point for the trade may not be optimal.

“Beginning a 10-year point-to-point with the market at all-time highs and after more than five years of a bull market may not be the best timing,” he said.

“The real question is whether this is 1995 or 2000 in terms of the market’s position. This is the million-dollar question that will be debated endlessly with no real certainty.”

Jonathan Tiemann, president of Tiemann Investment Advisors, LLC, said that the long duration represents another serious risk: neither losing nor gaining over a long period of time.

The high leverage, the absence of a cap and the conservative barrier level are achieved through some important concessions investors are willing to make when buying the notes, he said.

Dividends

“The leveraging is the result of giving up dividends. You get more leverage on the Euro Stoxx notes because the yield on the Euro Stoxx is higher,” he said.

The Euro Stoxx 50 has a dividend yield of 3.17%, compared with 1.78% for the S&P 500 index.

“Not only you don’t receive the dividends, you also don’t get compensated on the potential reinvestment of the dividends,” he said.

“You sacrifice not just the income but the reinvestment of the income, and that’s over a 10-year period. Ten years is a long time.”

The 1.59 and 2.16 times leverage factors of the S&P 500 and Euro Stoxx 50 deals, respectively, enable investors to outperform the market given the uncapped return, he noted. But not necessarily all the time.

“Over a 10-year period, with that type of leverage you come out ahead of the market if the market is strong even without the dividends,” he said.

“But if the market bounces around and moves up a little bit and down a little bit, you could end up just getting your money back and getting behind the market because of the sacrifice of the dividends.”

Assessing value

When trying to decide whether to invest in these products or not, investors should compare the benefits of the notes to other investments.

“There may be easier and more flexible ways to get the leverage play of the underlying indexes,” he said.

“At first glance, it looks like they are paying you for investing long-term and giving up the dividends. You’re getting a lot of leverage and protection. You don’t have a cap.”

But investors should compare these investments to 10-year zero-coupon bonds issued by UBS and Deutsche Bank, he said.

“You need to know what type of return you’re giving up in order to measure the value of the product. If all you get is your money back after 10 years, you get pretty behind relative to a pure credit play. You have to evaluate how these notes compare to lending money to UBS and Deutsche Bank for 10 years,” he said.

Barrier value

Tiemann downplayed the risk of losses even though a loss by virtue of the 50% barrier would represent at least 50% of the original investment. The long duration coupled with the level of protection lessens the risk in his view.

“Getting this 50% barrier is appealing. But you have to wonder how valuable it is over a 10-year period when the payout is point to point. The odds that the market will be half of what it is now are very small,” he said.

“It doesn’t really cost them that much to provide that protection.

“But you as an investor, you’re taking on some serious liquidity risk associated with that 10-year duration. You would get disappointed if after making the decision to buy an illiquid investment for 10 years you ended up only getting your money back. Think about that: you can always buy a 10-year Treasury strip for about 75% of its fair value.”

Real risk

The biggest risk of this product is the opportunity cost, he said.

“Imagine if after 10 years all you get is your money back. You made nothing. Your money has just been sitting here doing nothing all that time. That’s the real risk: the opportunity cost,” he said.

In such event, investors in the notes would not only underperform the equity market because they gave up dividends, they would also “get behind” Treasuries.

“I don’t really know who would buy the notes,” he said.

“The value of the leverage is diminished by the fact that you sacrifice the dividends.

“And the value of the protection is reduced by the long tenor and the opportunity cost,” he said.

UBS Financial Services and Deutsche Bank Securities Inc. are the agents for the Deutsche Bank deal. The Cusip number is 25157U614.

UBS Financial Services and UBS Investment Bank are the agents for the UBS notes. The Cusip number is 90273L799.

Both offerings were scheduled to price Tuesday and will settle Friday.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.