Barclays' trigger optimization notes tied to Euro Stoxx seen as plain vanilla, for mild bulls

By Emma Trincal

New York, Jan. 6 - Barclays Bank plc's 0% trigger return optimization securities due Jan. 31, 2017 linked to the Euro Stoxx 50 index offer leverage and barrier protection for investors expecting limited upside in the euro zone benchmark. But the fees, seen as above average, reduce the appeal of the notes, sources said.

If the index return is greater than zero, the payout at maturity will be par of $10 plus 1.5 times the index return, subject to a maximum return that is expected to be 40% to 50% and will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

If the index return is zero or negative and the final index level is greater than or equal to the trigger level, 75% of the initial level, the payout will be par.

If the final index level is less than the trigger level, investors will be fully exposed to the index's decline from its initial level.

Plain vanilla

"These are large stocks. It's not an ostensibly really risky investment," said Carl Kunhardt, wealth adviser at Quest Capital Management.

"It's a plain vanilla deal, which is what I like. It doesn't have bells and whistles or artificial pump-up of the returns. You can easily explain it to a client.

"In addition, Barclays is a good credit. Single A is the highest you're going to find with financial companies. So I think it's a pretty nice deal."

Michael Kalscheur, financial adviser at Castle Wealth Advisors, said that his assessment of the notes is good.

"Barclays has a strong rating and is a sound underwriter. No problems here," he said.

"The index is easy to understand and, in my opinion, fairly valued, so it has some upside potential.

"The three-year term is good - not too long, especially for the upside cap.

"The 1.5 leverage factor on upside is very nice, and while there is a cap, annualized returns are in the 13% [to] 16% range without compounding. That's definitely acceptable after the big 2013 year."

The index return last year was 24.5%.

Acceptable protection

On the downside, Kalscheur said that the protection is "acceptable" even though a barrier is "not as good" as a buffer.

"The 25% European barrier is very enticing. The size of the protection and the fact that the barrier is only observed at the end of the term and not during the term makes it acceptable," he said.

Fee, yield

Among the less attractive features is the 2.5% fee.

"It's a bit expensive for a three-year product," he said.

In addition, the underlying index pays a higher dividend than the S&P 500, which leads investors in the notes to give up more in dividends.

"The yield on the Euro Stoxx is 2.77%, which is very high versus the S&P 500's 1.87%. That means you are giving up almost 1% extra per year in lost dividends," he said.

"But overall, my assessment is good. It would not be my first choice, but it has enough positives to be worthy of consideration."

Weak barrier

A market participant said that the terms are "not all that great" partly because of the relatively high-yielding underlying benchmark, which makes for a higher opportunity cost to the investor but also because of the low volatility of the index.

"The 75% barrier is not much when you think about it," this market participant said.

"We have roughly a 3% dividend yield on the index. After three years, the index would be up by 9%, so your real barrier is nine points higher at 84%. It's not a lot.

"The implied volatility I have for this index on a 24-month basis is 18.5%. It's relatively low, and I assume that it's probably not that far away from what you'd have for three years. With that you don't get a lot to price decent terms.

"The volatility skew toward the downside is relatively high. It gives you more to price a barrier. But we have this 75% trigger, which is not that interesting. A 25% drop over three years can happen, and your barrier can be easily breached."

Bullish bias

"I have a bullish bias, so I am more concerned with the cap," he added.

He said he is bullish on equities in general because "despite rich valuations, where else can you go?"

"If the central banks continue to give money for free, people will remain in stocks as long as they have to in order to get some yield. Look at 2013. Bonds have had at best slightly positive returns or flat returns as long-term interest rates have increased. Bonds therefore are not an option. Commodities have had negative returns, hedge funds have had zero or negative returns. You can only put so much money in real estate because it's less liquid and it's correlated to stocks," he said.

The cap on the notes is going to "work against the investor" in two ways, he said: "It's going to really hurt the pricing of the product as well as your return."

Cap and fee

While bullish on the Euro Stoxx, the market participant ruled out the idea that the index would generate 25% every year. But assuming a 15% per year return for instance leveraged by the 1.5 factor, the 67.5% gain obtained over three years would be well above the 40% to 50% cap.

"The cap is an issue for your performance. But it's also a problem because it hampers the pricing of the notes. It diminishes the mark-to-market value of the product. You're stuck with the notes for three years. If the market goes up, you have the leverage, but the cap works against you," he said.

UBS Financial Services Inc. and Barclays are the underwriters.

The notes are expected to price Jan. 29 and settle Jan. 31.

The Cusip number is 06742K204.

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