JPMorgan's buffered enhanced notes tied to iShares MSCI EAFE offer less leverage, higher cap

By Emma Trincal

New York, May 6 - JPMorgan Chase & Co.'s 0% buffered return enhanced notes due Nov. 30, 2012 linked to the iShares MSCI EAFE index fund are for more bullish investors than the typical buyer of enhanced growth products given the notes' moderate leverage and a slightly higher cap, said structured products analyst Suzi Hampson at Future Value Consultants.

The payout will be par plus 1.5 times any gain in the fund at maturity, capped at a maximum total return of 18% to 22%, according to an FWP filing with the Securities and Exchange Commission. The exact cap will be set at pricing.

Investors will receive par if the shares fall by up to 10% and will be exposed to declines beyond 10%.

"We see a lot of those accelerated growth products, but this one is shorter than usual in duration. It also has a moderate 1.5 gearing compared to many other leveraged deals, which often give you two to three times leverage," she said.

Hampson noted that the lower leverage factor in this deal allowed the issuer to offer a shorter-dated product and perhaps a slightly higher cap.

"Products with more leverage would have to either give you a lower cap or a longer term," she said.

Bullish, more bullish

Investors in this product with less leverage than the norm would have to be more bullish, said Hampson.

"The lower gear and the higher cap make this product appealing to more bullish investors who expect to see more growth of the underlying," she said.

"Someone using three times leverage does not have to be that bullish."

On the other hand, investors in the notes have a different profile from those buying the fund directly, she said, suggesting a less bullish outlook.

"With these notes, you can outperform the fund both on the upside and on the downside. The only time you're better off with a direct equity investment is when the fund grows above the cap," she said.

On the downside, the notes will outperform the fund if the fund declines by less than 10%, she said. On the upside, investors will beat the fund if it finishes between the initial price and the cap, she added, because investors will get 1.5 times the return.

"This product is for someone who would normally invest in the fund but who would be looking for a less risky alternative," she said.

Low riskmap

The notes stand at a lower end of the risk spectrum with a 3.95 riskmap.

Riskmap - a Future Value Consultants rating - measures the risk associated with a product on a scale from zero to 10. The score is based on recently rated structured notes.

Hampson said that the 10% buffer explained the reduced risk. But the short-term duration also played a role.

"If you compare this product with a similar structure on a four- or five-year term, you have less risk because there is less of a chance to go below the buffer," said Hampson.

The short duration does not just lessen market risk; it also reduces some of the credit risk, she said.

In addition to that, this issuer's creditworthiness is relatively good, Hampson said, based on a review of the bank's credit default swap spreads.

JPMorgan has a 75 basis points CDS spread, compared with 120 bps for Citigroup and 140 bps for Morgan Stanley, she noted.

The CDS spreads are indicative of funding levels and determine somewhat the risk/reward profile of the product, Hampson said.

The lower the CDS spread, the lower the riskmap but the less attractive the terms of the deal may be, she explained. "An issuer with wider spreads and therefore more credit risk should be able to offer more attractive terms."

The historical volatility for the iShares MSCI EAFE index fund, at 29%, is greater than the S&P 500. But it remains lower than many other global equity funds, she said.

Return and value

At 5.96, the return score of the product is higher than the 4.5 average, Hampson said.

The return rating is Future Value Consultants' indicator, on a scale of zero to 10, of the risk-adjusted return of the notes.

The probability tables of product return outcomes reveal that investors in the notes have a 70% chance of generating a gain versus 30% of incurring a loss.

The value rating is "very high," said Hampson, at 9.67 on a scale of zero to 10.

This rating represents the real value to the investor after deducting the costs the issuer charges in fees and commissions on an annualized basis.

"It could be because there are many competitive products on this underlying, so it's tightly priced," she said.

"Also, it's still a month away before it prices. And you have a cap range between 18% and 22%. We do our pricing at a more generous level than mid-point. We use 75%, so we based our analysis on a 21% cap, which is near the higher end."

The overall rating, on a scale of zero to 10, is 7.95. This score is Future Value Consultants' opinion on the quality of a deal, taking into account costs, structure and risk/return profile.

The notes (Cusip: 48125XPF7) are expected to price May 25 and settle May 31.

J.P. Morgan Securities LLC is the agent.

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