Deutsche Bank’s autocalls tied to three oil stocks show high yield, but one stock is a wildcard

By Emma Trincal

New York, Jan. 29 – Deutsche Bank AG, London Branch’s phoenix autocallable securities due Feb. 1, 2019 linked to the least performing of the common stock of Carrizo Oil & Gas, Inc., the common stock of Chevron Corp. and the common stock of Hess Corp. offer a very attractive coupon, but one of the three underlying stocks is a concern, buysiders said, as they are not familiar with the name of the company whose stock is highly volatile.

Each quarter, the notes will pay a contingent coupon at an annual rate of 22% if each stock closes at or above its coupon barrier, 70% of its initial share price, on the observation date for that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be automatically called at par if each stock closes at or above its initial share price on any quarterly observation date.

The payout at maturity will be par plus the final coupon unless the least-performing stock finishes below its trigger price, 70% of its initial share price, in which case investors will lose 1% for each 1% decline of the least-performing stock from its initial price.

Three stocks

Michael Kalscheur, financial adviser at Castle Wealth Advisors, said the deal was “interesting” particularly given the 22% annual coupon, which is 5.5% per quarter. But he added that his firm usually does not take a look at these kinds of notes.

“It’s based on three stocks. We avoid individual stocks,” he said.

Also his firm sticks to longer-term investments.

“The autocall makes it likely that you’re in not even in for one year but for three months. We don’t do three months investments for our clients. Even a one-year would be too short for us,” he added.

Getting it all

The 22% was “enticing,” but investors were unlikely to receive the full coupon amount for the year.

“I think the temptation is to look at this 22%. That’s what you’re shooting for and it’s probably not going to happen,” he said.

“The probabilities of getting called on the first date are always huge. Chances are you’ll get called after three months with a 5.5% gain and that’s the end of it.”

The most likely outcome – an early redemption in three months – was not necessarily a bad one. But it presented risks.

“It comes down to the fundamentals of bonds. You have the reinvestment risk. If I get called I think the odds of getting the same coupons are pretty low,” he said.

Unknown duration

The notes are likely to be redeemed early. Statistically the chances of a call on the first call date are the greatest. But it does not mean that investors are guaranteed to get their money back in the short term.

Investors should not assume that the length of their investment will be three months. Duration for those autocallables is always an unknown, he noted.

“It would be great for someone who needs their money in three months. But you can’t do that because there’s no guarantee that it’s going to be a three months.”

Hess

Another problem for Kalscheur was the underliers, or more specifically two of the three stocks.

“Everybody knows Chevron. You can safely take them in the trash can. You know it’s not going to be the worst of,” he said.

Hess Corp., a large-cap stock, carried a red flag in, based on Morningstar’s opinion, which sees the stock as overvalued, he noted.

“The stock trades at $52 a share. Morningstar thinks the fair value is at $35. They have a ‘consider selling’ price of $47.50. A 30% drop would take it to $36.40, still above its fair value. Do I think a 30% price decline is possible within one year? You bet. So I wouldn’t be comfortable with this one.”

Carrizo

But the real risky stock, according to him, was Carrizo Oil & Gas, a smaller company with a $1.9 billion market capitalization.

The share price trades at $21.00. The stock has lost nearly 41% of its value over the past 12 months. Its implied volatility of 55% is elevated compared to the overall sector. The Energy Select Sector SPDR exchange-traded fund shows an implied volatility of 17%.

“I’ve never heard of them. My extended family makes more money than this company does,” he said.

“I’m not trying to beat up on Carrizo. But it’s a worst-of so you have to look at the one that’s likely to drop the most in price.

“I think this is the one with the greatest probability.

“The implied volatility is off the chart.

“If I knew the company I could say it has sold off way too hard, it’s ripe for a huge run.”

Indeed, the company’s share price has increased by more than 33% in the past six months after hitting an all-time low in September.

“But if I felt so strongly about the stock, I would just buy it outright. I wouldn’t mess around having it as the underlying of a structured note, especially a worst-of,” he said.

“That’s the deal-killer for me.”

Since Kalscheur said he did not know the stock and found it too risky, he would have to reject the deal altogether.

The autocallable and contingent coupon were “enticing,” he said. But the likelihood of being called after three months did not make the deal suitable for his clients.

“You’re teaching your clients to trade. That’s not our shop,” he said.

Wildcard

Carl Kunhardt, wealth adviser at Quest Capital Management, expressed similar concerns about the underlying stocks and the likelihood of an early call.

“The wildcard here is Carrizo. Chevron is a proxy for the oil and gas company. It’s a large multinational company. Hess is also a wildly known large-cap. But these little oil companies that own a few wells could be up 300% in one quarter and down 150% the next.

“It’s impossible to evaluate the notes unless you have a fairly good understanding of the three companies,” he said.

More blue chips

One alternative would be to replace Carrizo with a better-known, larger oil company stock with the understanding that the contingent coupon would not be as high as 22%.

“If you swap the company out for Exxon or BP and stay with the big boys, that might be a trade-off worth considering,” he said.

“In that case I could recommend it to an aggressive investor for a small amount. But it would depend on the coupon. If I get 3.5% a quarter, yes. But it can’t be too low.”

Even with less volatile underlying stocks and by limiting the trade to more aggressive investors in small sizes, Kunhardt said he was not sure he would buy the product because of the autocall.

“The note will not get past the first quarter. It will get called. Then what? If you’re not called after three quarters, it’s not a good sign. You’re exposed to oil prices. It’s a very volatile sector.

“Overall it’s too much risk for my appetites.”

Deutsche Bank Securities Inc. is the agent.

The notes will settle on Thursday.

The Cusip number is 25190LAF7.

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