JPMorgan’s $2.22 million contingent coupon autocallables offer worst-of bet on telecom stocks

By Emma Trincal

New York, Dec. 1 – JPMorgan Chase Financial Co. LLC’s $2.22 million of autocallable contingent interest notes due Nov. 27, 2019 linked to the least performing of four telecom stocks offered compelling terms, but some risks associated with the individual stocks and the autocallable feature were dissuasive, financial advisers said.

The structure payout is a worst-of. The four underlying stocks are AT&T Inc., Verizon Communications Inc. and T-Mobile US, Inc. and the American Depositary Shares of Vodafone Group plc, according to a 424B2 filing with the Securities and Exchange Commission.

Each month, the notes will pay a contingent coupon at an annual rate of 9.35% if each stock closes at or above its 55% barrier level on the review date for that month.

The notes will be called at par plus the contingent coupon if each stock closes at or above its strike level on any quarterly review date other than the first, second and final review dates.

The payout at maturity will be par plus the final coupon unless any stock finishes below its 55% barrier level, in which case investors will lose 1% for each 1% decline of the worst-performing stock.

Credit profile

“JPMorgan has a good credit profile. It’s a very nice coupon. There’s a pretty large barrier. But when you get into those sector-specific plays, I’d take a closer look at the downside risk,” said Steve Doucette, financial adviser of Proctor Financial.

Doucette has purchased autocallable contingent coupon worst-of notes before. But he prefers when the underliers are broad-based equity indexes.

“If one of those four stocks bust through the barrier, you would get seriously hurt,” he said.

Telecom rally

He had in mind one of the reference stocks, Vodafone, which dropped this year by 13.5%. Vodafone Group plc, a British global telecommunications company, is the only loser so far. The three other stocks are up for the year, in particular T Mobile, which has soared by 38%.

Over the past three years, T-Mobile more than doubled in price; Verizon has remained flat; and AT&T has gained 10%. In sharp contrast, Vodafone during that period has lost 35% of its value.

“You’ve got this one that’s tumbling. There is always a possibility to breach the barrier if you have a volatile stock like this one,” he said.

Potential downside

One way to assess the risk would be to examine the performance of each underlying stock during the financial crisis of 2008.

All three U.S. stocks held better than the overall market: AT&T fell by 31%, T-Mobile was down 24% and Verizon dropped 22% versus the 37% fall of the S&P 500 index during that year. The exception was Vodafone, which plummeted 45.25%, enough to breach the 55% barrier (a 45% decline) and cause investors to lose “a massive amount of money,” he noted.

Sectors, stocks

“We don’t follow sectors. I don’t have any particular knowledge of this industry and I wouldn’t try to make predictions. We know that it’s a fast-changing sector, and since we’re not focusing on it, we wouldn’t make sector-specific bets,” he said.

Even more important for Doucette was to avoid placing bets on single stocks in general.

“With stocks you’re taking a business risk, which is potentially more dangerous than market risk,” he said.

The worst-of structure added another dimension to the risk with correlation.

“You’re not investing in a sector and you’re not investing in a basket of four stocks. It takes only one to bring down the entire portfolio,” he said.

Despite the barrier and coupon, Doucette said he would not consider the notes.

“We do asset allocation. I’m not going to expose myself to the business risk of any of those four companies,” he said.

The pros

Matt Medeiros, president and chief executive of the Institute for Wealth Management, viewed some of the aspects of the product as positive. But he was reluctant to endorse the cost as well as the autocallable feature.

“JPMorgan would not be a concern for us in terms of credit risk,” he said.

“I like the fact that the underwater barrier is very deep.

“I think the sector in itself, with all the changes in the mobile device industry, is interesting. I may not go as far as saying that I’m bullish on telecom, but I’m certainly optimistic.”

The notes offered a generous coupon, which limited concerns some investors may have about missing on some of the upside.

While most of the reference stocks are rallying, they also have some potential downside risk, which the barrier at maturity helped contain.

“You’re taking relatively volatile names and monetize the return. The yield is pretty good and the barrier to get the coupon is generous,” he said.

Call risk

Medeiros’ main objection was the possibility of a very early call, as early as three months after issuance.

“My concern is the early redemption. This note could be called within a very short period of time. There’s a higher probability of this thing getting called than getting a long-term stream of income,” he said.

“It’s unpredictable. When you look at income you want to be able to rely on income. It’s a 9.35% yield, but you may just get a quarter of that if you get called after three months.”

Fee

Such a scenario represents several disadvantages for investors, he said.

First, the noteholders would only get a portion of the coupon, or 2.34%, if the notes were to get called on the first call date.

Second, they are subject to reinvestment risk. “You never know for sure if you’re going to find the same yield,” he said.

Finally the cost of the notes – the 3.32% fee is paid upfront – would be overly expensive on a shorter duration.

“A 3% fee payable upfront appears to be high,” he said.

The securities are guaranteed by JPMorgan Chase & Co. J.P. Morgan Securities LLC is the agent.

The notes (Cusip: 46646QAU9) priced on Nov. 22.

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