JPMorgan’s $14.05 million notes on 10-year SOFR ICE swap rate offer deep-in-the-money digital

By Emma Trincal

New York, March 16 – JPMorgan Chase Financial Co. LLC’s $14.05 million of 0% digital notes due March 22, 2023 linked to the 10-year dollar SOFR ICE swap rate showed a rate product using a structure often applied to equity-linked notes. The payout offers a positive return when the underlying falls well below its initial level, the equivalent of a “deep-in-the-money” digital call option.

If the swap rate finishes at or above its initial value or falls by up to 45.8%, the payout at maturity will be par plus the contingent digital return of 8%, according to a 424B2 filing with the Securities and Exchange Commission.

If the swap rate falls by more than 45.8%, investors will lose 1.84502% for every 1% that the rate declines beyond 45.8%.

Floaters preferred

Most interest-rate-linked notes offer full principal protection but not this one, observed a market participant.

“In my book there are two types of bonds: fixed-coupon and floating-rate notes,” he said.

“Usually when interest rates go up, bond prices go down. But that’s not the case with floating-rate notes because they adjust periodically, so the price doesn’t drop.

“With floating-rate notes, your coupon is at risk, but your principal is protected. I’d rather do that than putting my principal at risk even for an 8% coupon.

“Of course, it’s all relative. If you don’t expect rates to either go up much or go down much, you may be tempted to take the full downside risk for this type of yield. To me, this is not what a bond is. Bonds are conservative. They’re designed to balance your risk and your return.

“So, I wouldn’t use this.”

New swap benchmark

The publication of the U.S. Dollar SOFR ICE Swap rate began in November 2021, and, therefore, has a limited history, warned the prospectus.

The ICE Benchmark Administration launched the U.S. Dollar SOFR ICE Swap rate for use as a reference rate for financial instruments in order to aid the market’s transition to SOFR and away from Libor. Since then, USD Libor-linked swaps have been replaced with SOFR-linked swaps.

Downside range

The reference rate was at 1.51% on the strike date.

Investors in the notes do not expect the U.S. Dollar SOFR ICE Swap rate to drop more than 54.2%, which takes the swap rate down to 0.813% in one year, at the buffer threshold.

“That’s a big drop. A 55% decline is a lot, and you get a buffer for your protection,” said a sellsider.

“And 8% for one year is pretty good.

“If the rate goes down by a little bit more than half from its current level, you get 8%. If it’s up a tad, you get 8%.

“You can buy this note even if you see the rate going lower as long as it’s not below 0.8%.

“I think it’s a fair deal. They’re giving you a lot of protection with a compelling return.”

Yield curve expectations

The main risk would be to see rates on the long end of the curve going lower, he said.

“Right now, it’s the short end of the curve that’s rising with the Fed. The long end is not going up that much. In fact, the curve is flat. Can it go flatter? Well, possibly. Can it go inverted? It’s possible. It depends on your expectations about inflation and the economy. If you’re bearish on the economy, then yes, you could see an inverted curve.

“But to be at risk, the rate would have to drop 70 basis points. That’s a big move.

“I feel pretty comfortable that the 10-year is not going to drop that much,” he said.

The notes are guaranteed by JPMorgan Chase & Co.

J.P. Morgan Securities LLC is the agent.

The notes settled on March 10.

The Cusip number is 48130UC94.

The fee is 1%.

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