Barclays' autocallables on Russell 2000, Euro Stoxx 50 show less risk than similar products

By Emma Trincal

New York, May 2 - Barclays Bank plc's 0% annual autocallable notes due May 5, 2017 linked to the performance of the Russell 2000 index and the Euro Stoxx 50 index include a step down in the call level, which helps reduce the market risk usually associated with these types of products, said Suzi Hampson, structured products analyst at Future Value Consultants.

The notes will be automatically called if both indexes close at or above the call level on any of three annual call dates, according to a 424B2 filing with the Securities and Exchange Commission.

The redemption payment is par plus a call premium of at least 11.3% per year. The call level is equal to the initial level for the first call date, 95% of the initial level for the second call date and 90% of the initial level for the final call date.

If the notes are not called and the final level of the lesser-performing index is at least 75% of its initial level, the payout at maturity will be par. Otherwise, investors will be exposed to the decline of the lesser-performing index from its initial level.

Hampson said that Future Value Consultants categorizes this type of structure under the name "lesser review."

Lesser review products are autocallable worst-of notes, she explained.

"Worst-of products with an autocallable feature are common enough to warrant their own category. By nature, those products tend to be risky," she said.

"We have the worst-of treatment for the calls and the barrier. For the calls, both underlying indices need to be above the call level. For the final barrier, only one of them is enough to breach the barrier, which automatically links your return to the worst-performing index."

But the notes introduce a feature that diminishes the amount of risk, she said.

"The issuer here has included what we call the defensive autocall. The call level is falling with each year that passes. The issuer will call the notes based on a schedule of declining call levels, with each call trigger getting lower on each annual call date. You may call that a step down," she said.

"Since the threshold drops as you go along, it should increase the chances of getting called."

Worst of

Despite their inherent risk, lesser review notes tend to be popular among investors for the higher returns they tend to pay as compensation for the autocall and the worst-of feature combined, she explained.

"These structures are a way for the issuer to be able to offer higher returns in the current pricing environment marked by low interest rates," she said.

"It gives investors the opportunity to buy products still linked to underlying indexes they are familiar with. The flip side is that losses will reflect the negative return of the worst underlying. It's a lot more risky than a regular autocall. Since it only takes one of the two indices to breach the barrier, your chances of losing money are higher, which is why they're paying investors a higher premium."

Low correlation

Investors using worst-of structures should pay attention to the correlation between the underliers, she said.

In this case, the Russell 2000, which is the U.S. small-cap benchmark, is not very correlated with the Euro Stoxx 50, the large-cap index for the euro zone. Their correlation coefficient is 0.62, which "is not high," she said.

"It's a lot lower than the correlation between the S&P 500 and the Russell 2000 for instance or the correlation you would have between two European indices," she said.

"When the underlying indexes are not correlated, the chances of getting called are lower and the odds of breaching the barrier at maturity are greater."

Variable call levels

A more positive attribute of the note is the declining call level, she said.

"The defensive kick-out levels lower the risk a lot compared to other worst-of autocallables. The call level after one year is 100%. Then it becomes 95% and finally 90%. It is progressively more defensive. As you lower the levels, it increases the chances of getting called," she said.

And getting called should be the objective of investors in these products, she noted.

"Since your return is going to be the call premium, if any, you do want to be called and earn the 11.3% annualized return. That's the whole idea," she said.

"So this product offers some balance. On the one hand, the worst-of structure in addition to the low correlation between the two underlying indexes increases the risk. But the good news is that you have a step down, which reduces the negative impact of those risk factors."

Digital-like

Investors in this product are looking for a fixed return. However, they do not have the profile of fixed-income investors, she said

"While the return is fixed it is not guaranteed. You get paid under certain conditions," she said.

"This product shows features common to a fixed-interest product in that you are not going to participate in the index growth. Your call premium is a cap. But this product is more like a digital play. You'll either get paid or you won't."

No bulls

Investors in the notes do not have the profile of bullish investors since they do not get to participate in the upside of the underlying indexes.

"This is not for bulls. In fact, buying the product which comes with the step down suggests that you must have a defensive view and anticipate those indexes to stay relatively flat. No need for growth here if you want to get your return. If your view is bullish, you're better off with a note that offers upside participation," she said.

"Inversely, this is also not suitable for bears. If you're really bearish, the step down doesn't guarantee that you'll get called, and the final barrier could be easily breached."

Finally the notes are not designed for risk-averse investors.

"While the risk has been reduced compared to similar products, you still have a significant chance of breaching the barrier. There will always be a fair amount of risk when you invest in a note whose return is tied to the worst performer. However, the scores will indicate that this particular product shows less risk than its peers, which is not to say that it's not risky compared to all products," she said.

Low market risk

The riskmap is Future Value Consultants' measure on a scale of zero to 10 of the risk associated with a product with 10 as the highest level of risk possible. It is the sum of two risk components: market risk and credit risk.

"There is a 75% barrier, which is not observed throughout the life of the notes but only at maturity. It's an advantage for investors. The worst index can hit the threshold anytime as long as it doesn't happen on the final day," she said.

The notes show a 3.36 market riskmap, compared with an average market riskmap of 3.71 for the product type.

"We have less market risk than the average worst-of autocall because many of those products are tied to more than two underliers. It could be three or even five. They can also be linked to stocks or to more volatile indexes. There are definitely more risky products out there. Even though the Russell and the Euro Stoxx are not very correlated, they're also not that volatile," she said.

"Plus you have a 75% barrier, which is a good level.

"Finally, the decreasing level for the kick-out is perhaps the most significant risk-mitigation factor."

Yet the product remains riskier than the overall universe of notes recently rated by Future Value Consultants, which have an average market riskmap of 3.05.

Credit risk

The credit riskmap of the notes is 0.51. The average credit riskmap in the lesser review category is 0.52.

"It's very average. And that's good. It's what matters because all products are going to have some element of credit risk. You just don't want to see any kind of red flag," she said.

Barclays' five-year credit default swap spreads are 73 basis points as of Friday, according to Markit, the financial information services company. Citigroup's spreads are 72 bps and Morgan Stanley's are 75 bps.

Overall and given the below-average market risk, the product's riskmap at 3.87 is less than the average, with the category scoring an average of 4.23.

Return score

Future Value Consultants measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions: neutral assumption, bull and bear market and high- and low-volatility environments. A risk-adjusted average return for each assumption set is then calculated. The return score is based on the best of the five scenarios.

The bullish assumption is the best of the five scenarios with this product, according to Future Value Consultants' report.

The notes under this assumption received a 7.13 return score versus 7.11 for the average in the category.

"It's solid but also pretty average. It's slightly higher than the average of all product types, but it's in line with the average of similar products," she said.

The average return score for all products recently rated is 7.01.

"The product choice boils down to the underlying or the level of risk investors are willing to take. But in terms of risk-reward, this product is consistent with the norm in this group," she added.

"All our scores are used to compare products within the same group or based on the entire universe of structured notes that we have recently rated. The scores, including the return score, are more valuable when investors have to deal with a complex product, such as this one. This note has so many moving parts between the two underlying, the correlation coefficient, the decreasing call levels, the payoff type, the barrier. It makes more sense to look at the scores when you have so much going on. It would be close to impossible to compare the product's risk-return profile without some kind of scoring."

High price score

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10.

This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

The price score for the product is 7.32. In comparison, the average for products of the same type is 6.16.

"The price score is very encouraging. It suggests this product is pricing above its competitors. We have set terms, I mean by that nothing in the prospectus is stated as a range, which helps a lot in terms of coming up with a more definite score," she said.

Good overall score

Finally, the overall score measures Future Value Consultants' general opinion on the quality of a deal. The score is the average of the price score and the return score.

This overall score is 7.22 for this product versus 6.63 for the average.

"The overall score is quite solid. It is beating the average of other products in the same category. This deal is appealing because it shows a lower level of risk than other similar products," she said.

"We have a low riskmap and a high price score. It sounds quite good."

Barclays is the agent.

The notes settled on Friday.

The Cusip number is 06741UCY8.

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