UBS' trigger phoenix notes tied to JPMorgan differ from pure autocallables with pros and cons

By Emma Trincal

New York, June 24 - UBS AG, London Branch's upcoming trigger phoenix autocallable optimization securities due June 29, 2012 linked to JPMorgan Chase & Co. shares offer a structure very similar to a pure autocallable, but significant differences exist regarding the coupon and downside risk, said Tim Mortimer, managing director at Future Value Consultants.

If the price of JPMorgan stock closes at or above the trigger price - 80% of the initial share price - on any of four quarterly observation dates, the issuer will pay an annualized contingent coupon of 10% to 12.5%. The exact rate will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

If JPMorgan shares close at or above the initial price on any of the observation dates, the notes will be called at par of $10 plus the contingent coupon.

If the notes are not called and JPMorgan stock finishes at or above the trigger price, the payout at maturity will be par plus the contingent coupon. Otherwise, investors will be exposed to any losses.

Different animals

Mortimer explained the main difference between this "hybrid" structure and the standard autocallable structure.

The first one related to the relationship between coupon payments and callability.

"With an autocallable, you get paid only when you're called. You don't get anything unless the notes are called," he said.

"With this, you can earn a coupon and not get the call. If you're anywhere between 80 and 100 on the call date, you get the coupon, but there is no early redemption."

A second difference involved how coupon payments can accumulate with autocallable structures that pay interest and how they don't with this product.

"With the autocallable, you get to receive all the coupon payments due from the issuance date. If you get called on the third quarter, you get nine months' worth of interest," he said.

So for instance with similar terms, an autocallable carrying a 10% coupon would give investors 7.5% on the third observation date, he said.

"With this, say you are above 80 on the third quarter for the first time since the beginning. You're only going to get your coupon for this quarter and not for the preceding quarters. You only get 2.5% instead of 7.5% in the case of the autocallable."

This does not necessarily mean that investors in these notes are more likely to get paid nothing.

"The chances of getting no coupon at all are limited," said Mortimer.

"For you not to get any coupon, you would have to see the stock fall by more than 20% on the first quarter and it would have to stay there. You'd think it's pretty unlikely," he said.

Still, investors in this product may end up with less if the coupon payments do not add up.

Contingent coupon

There is, however, a mechanism designed to offset this problem, Mortimer explained.

"Traditional autocallables will pay you a fixed amount. And you only get paid when you get called. Here, you may not get a coupon on the first and second quarter and get it on the third. It creates a level of uncertainty," he said.

"But there is a trade-off for the uncertainty. You're going to get a higher rate with a contingent coupon than with a fixed rate.

"By making the coupon contingent, you're able to boost the coupon amount."

More protection

If the notes do not get called, this structure also offers some benefits on the downside, Mortimer noted.

"With these notes, investors may be able to get some coupon payments even if there is no call," he said.

"For instance, suppose you don't get called but that you received two coupon payments. At maturity, you finish at 105. It gives you 5% of additional protection before any loss of principal."

If the same thing happens with an autocallable, the investor receives no call premium and therefore no additional protection. "Your principal in that case is more at risk," he said.

The fact that one may collect coupons without triggering a call adds a level of protection to this structure, he explained.

The additional cushion somewhat compensates investors in this product for the risk of not adding up as many coupon payments as the investor in a coupon-bearing autocallable would.

"You're actually transferring the risk. You're giving away some of the upside and getting more downside protection eventually," he said.

"You can tolerate some decline and still get some coupon. It softens the downside."

UBS Financial Services Inc. and UBS Investment Bank are the underwriters.

The notes will price on Tuesday and settle on Thursday.

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