Barclays’ $35.55 million notes tied to Facebook show rare instance of leverage on single stock

By Emma Trincal

New York, Aug. 31 – Barclays Bank plc’s $35.55 million of 0% Accelerated Return Notes due Sept. 15, 2017 linked to Facebook, Inc. common stock caught market participants’ attention because single stocks are rarely used for the underlying of leveraged structures. The size was also surprising given that such deals are uncommon.

The payout at maturity will be par of $10 plus triple any gain in the stock, up to a maximum return of 20.8%. Investors will lose 1% for each 1% of decline, according to a 424B2 filing with the Securities and Exchange Commission.

Rare

“We don’t see leverage on stocks very often,” a market participant said.

“There are some stocks that have a cult around them like Apple, Facebook, Google, Amazon. ... You can potentially do it on those names, but it’s unusual for the marketplace and for Merrill Lynch.”

BofA Merrill Lynch was the agent for this deal, ranked No. 7 in size last week, according to data compiled by Prospect News.

A benchmark business

Leveraged notes linked to a single stock are indeed rare, the data showed.

So far this year all leveraged notes (including those with full, partial or no protection) amounted to $10.88 billion as of Tuesday. Single stocks made for only $135 million of this notional, or 1.25%.

BofA Merrill Lynch is dedicated to leveraged deals: about two-thirds of its business falls into that category, according to the data.

But the agent is primarily focused on leveraged products linked to equity indexes, which represent 92% of its leverage business, rather than single stocks, which it uses for less than 3% of this activity.

BofA Merrill Lynch this year has only priced six offerings of leveraged notes linked to single stocks totaling $135 million.

Barclays’ $35.55 million deal, which priced last week, was the largest among those six.

“It could have been a single client or a couple of clients coming together,” the market participant said.

“It’s pretty rich though for that type of transaction.”

The fee was 1.8%, according to the prospectus.

Raising the cap

From a pricing standpoint, using a single stock in this type of deal makes sense, a structurer said.

“It’s true that we see fewer single-stock deals with leverage, but this one has no buffer, and the high volatility will help with the cap,” he said.

At close to 30%, the one-year implied volatility of Facebook is almost double that of the S&P 500 index, he noted.

“There are many ways to structure leverage with or without a buffer, with a cap or without a cap,” he said.

“The starting point on this one is high cap, no buffer. That’s your structure.”

Selling the volatility enables the issuer to offer a higher cap, he said, explaining the structure as follows: Investors are buying the stock plus two at-the-money calls. The term “at-the-money” refers to the fact that the option strike is at the current initial price of 100, for example. The three-times leverage is built around the long position and the two calls, he explained.

Capturing the spread

For the cap, investors sell three higher-strike calls. The leverage, however, modifies the strike levels compared to the cap.

“The cap is at 21%, but you have three-times leverage, so effectively the strike for the three calls you’re selling is 107%,” he said.

“You’re buying two at-the-money calls and selling three out-of-the-money 107 calls.”

The current price of 100 is below the 107 call strike, which means that the option is “out-of-the-money.”

“You’re buying the stock and two at-the-money calls, and you’re selling three out-of-the money calls,” he said.

The higher the volatility the more premium investors can keep from the sale of the calls.

“Whenever you get value, you can apply it wherever you want but not everywhere you want.

“Some deals are about protection. This one is a higher cap deal.”

It makes sense to use this type of volatile underlying stock when investors want a higher return, he said.

On such a short tenor, investors would be hard-pressed to find this nearly 20% annualized compounded cap along with a barrier or buffer.

“You can’t have everything, and you can’t compare this deal with a buffered deal. This is a no buffer structure,” he said.

“You’re still capped and you have no downside protection, but you get a higher cap and it’s a short tenor.”

The notes (Cusip: 06745B714) priced on Aug. 25.

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