Barclays’ $50 million worst-of notes tied to three indexes show 18% contingent coupon, call

By Emma Trincal

New York, March 13 – Barclays Bank plc priced $50 million of callable contingent coupon notes due March 5, 2021 linked to the least performing of the S&P 500 index, the Russell 2000 index and the Euro Stoxx 50 index, according to a 424B2 filing with the Securities and Exchange Commission.

The notes pay a contingent quarterly coupon at an annualized rate of 18% if each index closes at or above its coupon barrier level, 80% of its initial level, on the related quarterly observation date.

The notes are callable in whole at par on any contingent interest payment date starting in December prior to maturity.

If each index finishes at or above its barrier level, 80% of its initial level, the payout at maturity will be par. Otherwise, investors will be fully exposed to the decline of the least-performing index.

A matter of opinion

“Any time you buy a note you have to have a view. This is for someone who wants to outperform a range bound market. If all indices are trading sideways, you’ll get 18% a year. That’s a nice, healthy return,” said Tom Balcom, founder of 1650 Wealth Management.

“It’s a pretty big size deal. It looks like it was done for a [registered investment advisor] or an institution.”

Coupon boosters

What generated the high “healthy coupon” was in part the three underlying indexes versus the usual two, he said.

Another factor pushing up the coupon was probably the use of a discretionary call instead of the typical automatic call.

“It’s not as great for the investor as an autocall and that’s probably why you get paid more on this here... 18% is quite high,” he said.

The non-call provision allowing investors to be protected for the first nine months offset some of the disadvantage of the potential early redemption.

“At least you’re not getting called before December. In theory, you could collect the coupon three times in June, September and December so you get 13.5% over nine months.

“That’s very good.”

Not that simple

Balcom concluded by saying the size of the deal did not surprise him.

“Probably an institution bought it on the view that the market has reached the top. That makes sense. I like the deal for its healthy coupon even though we wouldn’t consider showing it. In general we don’t buy worst-of for our clients. We want to keep the structure really simple,” he said.

Overbought market

Steven Jon Kaplan, founder of TrueContrarian Investments, focused on the underlying market theme saying the notes were somewhat risky given current valuations.

“The timing is not ideal because these indices are highly valued right now, or close to their all-time high like the Russell a couple of days ago,” he said.

“I would prefer to see the return tied to less popular assets.”

Kaplan said the 20% contingent protection at maturity could be easily breached if the market evolves into bear territory, which is his deep conviction.

“It’s hard to say which of those three would be the worst-of. You would think of the Russell because of its volatility, but on the other hand, the S&P is so popular, it could end up losing a little bit more than the Russell,” he said.

Higher highs

One sign among many that the market is overpriced, according to Kaplan, is the comparison of current market levels with the highs seen in prior bear markets adjusted for inflation.

Talking about both the S&P 500 and the Russell 2000 indexes, he said that:

“If you compare the high of March 2000 with the high of October 2007 adjusted for inflation, these two were very similar.”

The two peaks marked the start of a bear market, the first one announcing the 2000-02 dot.com bubble burst and the second, the 2007-09 financial crisis crash.

“Now take the Russell and compare its current high with the high of 2007... those two peaks are no longer at similar levels. The market right now is at a much greater high even if you adjust for inflation. Same thing with the S&P,” he said.

Everest

In the last bear market (July 2007-March 2009 for the Russell and October 2007-March 2009 for the S&P, the Russell 2000 index lost 60% and the S&P 500 index dropped 58%.

“Now that the market is so much higher what do you think will happen? If it drops, it will be like falling from Everest,” he said.

Based on historical drawdowns and given the current market, which he views as overpriced, Kaplan said he believes a 70% drop is conceivable for the next bear market.

Pain ahead

“It’s not far-stretched to imagine a 70% decline two years from now,” he said. “Then the market recovers and at the end of the third year you’re only down 40% or 45%. Still, you’re way below the 20% level.

“This note is too risky in my opinion because 20% is not sufficient as we’re surely approaching a new bear cycle.

“The downside risk is compounded by the timing of the deal, how far the markets have gone up on a historical basis, how likely they are to drop and the high probabilities of sustaining heavy losses that would go way beyond the barrier level. And the risk increases as you go along as more and more unsophisticated investors are buying this market.”

Barclays is the agent.

The notes settled March 7.

The fee is 0.6%.

The Cusip is 06744CZN4.

© 2015 Prospect News.
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