JPMorgan’s digital coupon CDs linked to 10 stocks may offer sound alternative to regular CDs

By Emma Trincal

New York, Sept. 14 – JPMorgan Chase Bank, NA’s digital contingent coupon certificates of deposit due Sept. 30, 2022 linked to a basket of 10 stocks may offer the same yield as a traditional CD with the potential of earning more, said Kirk Chisholm, wealth manager and principal at Innovative Advisory Group.

The equally weighted basket includes AT&T Inc., CenturyLink, Inc., Exelon Corp., General Motors Co., HCP, Inc., Kinder Morgan, Inc., Murphy Oil Corp., Philip Morris International Inc., Potash Corp. of Saskatchewan Inc. and PPL Corp.

Interest is payable annually and will equal the sum of the weighted performances of the basket stocks, subject to a minimum interest rate that is expected to be at least 1.15% per year.

If a stock's return is greater than or equal to zero, its performance will be equal to the coupon cap. Otherwise, its performance will be equal to the greater of its return and negative 10%. The coupon cap is expected to be between 5% and 5.5%.

The exact minimum interest rate and coupon cap will be set at pricing.

The payout at maturity will be par plus the last coupon.

High yield

“On the upside the most you can get is 5%, but you also get at least 1.15% per year,” said Chisholm.

“I would start to look at the underlying stocks. It looks like a lot of those stocks are paying high dividends.”

The highest-yielding stock in the basket is CenturyLink with an 8.22% dividend yield. The lowest yield is 4.18% for Exelon. The average dividend yield of the basket is 5.70%.

The way these high-yielding stocks will perform depends a lot on future interest rate moves, he said.

“If interest rates start to rise, it would be a little bit of a negative. But if you think they’re not going to rise significantly over the next seven years –and I would be inclined to think that way – I suppose the investment could offer a reasonable trade-off,” he said.

Plain-vanilla CDs

While the interest rate paid depends on the performance of the components, Chisholm said the investment is still a CD with full principal protection and FDIC insurance. As such, it should be compared to a plain-vanilla CD.

“Right now, a seven-year CD will give you, give or take, 2%. The seven-year Treasury is at 1.87%,” he noted.

“Assuming you only get the 1.15% minimum each year, you’re lagging a regular CD by 85 basis points each year, which represents a total gap of 5.95%, or roughly 6% for the seven-year term.

“If you get 6%, you come out ahead of the traditional CD, which is not a lot. It’s just a little bit more than one year with the 5% cap.

“You are a bit behind a normal CD. Are you going to offset this gap over the course of seven years? I think you are likely to make up for the difference. At the same time, you have the potential to earn more than a regular CD with the 5%.

“If you have positive years, your stocks will give you a better return than a CD. You are a little behind in the worst-case scenario, but chances are you will make up for that difference.

“I like the odds of this versus a regular CD.”

Opportunity cost

Carl Kunhardt, wealth adviser at Quest Capital Management, pointed to the risk associated with a low correlation between the stocks.

“It’s attractive, but I’m not sure I would do it. What puts me off is the term,” said Kunhardt.

“It’s attractive because there is no market risk. You have the principal protection. With the CD format you’re also getting insurance against a credit event up to the FDIC limits.

“But the maximum return is 5%. There is sufficient volatility, sufficient non-correlation among the stocks that it’s unlikely I’ll hit the 5%.

“You may have stocks up 5%, 6% or 7%, but with what I suspect is a negative correlation between most of the names, the other stocks are going to drag your return down from the 5%.”

The stocks belong to a variety of sectors, including communications, utilities, real estate, energy, consumer goods (automobile, cigarettes), basic industrials, technology and telecoms.

“There is little or no correlation between those stocks,” he said.

“On the negative side, a stock return can contribute to a loss as low as 10% while on the upside, nothing can go beyond the 5% cap.

“In this market, it’s unlikely that you’re going to get 5%.”

Too long

Kunhardt’s main objection is the length of the product.

“I wouldn’t do that for a seven-year. If it was a three-year, I would be all over it,” he said.

“Seven years is long term. You’re either bullish or bearish over the long term. If these stocks generate double-digit returns, if I have a few that go up 20%, am I only going to make 5%?

“Regardless of the CD format, I see this as an equity play. And to lock myself over seven years for the guarantee of making a minimum of 1.15% doesn’t really make sense.

“I have the principal protection. I get that. But I’m giving up too much opportunity.”

Mysterious bucket

In addition, it would be difficult to decide in which bucket to place this market-linked CD.

“Would I put it in cash even though it’s equity? Should I treat it as fixed income because there’s a minimum coupon? No. It’s not going to have correlation with fixed income. I look at it from an asset allocation standpoint. Just because it gives me some income doesn’t make it a fixed-income instrument, not even a fixed-income substitute. The dividends of blue-chip stocks also give me income,” he said.

“It’s an interesting idea, but there are a few problems with it: It’s too long. It’s hard to allocate. And the lack of correlation between the stocks is not going to give me the maximum return, which at 5% is still too low, in my view.”

J.P. Morgan Securities LLC is the agent. Incapital LLC is distributor.

The CDs will price Sept. 25 and settle Sept. 30.

The Cusip number is 48125YPY4.

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