Barclays’ $29.92 million 7.5% STEP Income on Amazon provide bond substitute

By Emma Trincal

New York, June 2 – Barclays Bank plc’s $29.92 million of 7.5% STEP Income Securities due June 10, 2022 linked to the common stock of Amazon.com, Inc. provide fixed-income replacement to investors seeking income from a high-growth stock, sources said.

Interest is payable quarterly.

If the final price of Amazon’s stock is greater than or equal to the step level, 107.5% of the initial share price, the payout at maturity will be par of $10 plus 3.4%, according to a 424B2 filing with the Securities and Exchange Commission.

If the final share price is greater than or equal to the initial share price but less than the step level, investors will receive par.

If the final share price is less than the initial share price, investors will lose 1% for each 1% decline.

What’s in a name

A market participant said that advisers often use the terms “bond substitute” when buying income-oriented structured notes. He said a distinction should be made between the terms “bond substitute” and “synthetic bond.”

“Limited upside in the form of a coupon and no downside protection: that is not a synthetic bond. A bond issued by Amazon would give you your principal back. This one doesn’t,” he said.

“However, I have no problem with advisers calling it a bond substitute. It’s an income-generating note. It pays a guaranteed coupon. I’m going to take the downside risk and get a very different kind of yield than I would get with an Amazon-issued bond,” he added.

“As long as you’re comfortable with the risk, you can call it anything you want. You can call it bond substitute despite the lack of protection.”

BofA’s specialty

One important feature in this note compared to the commonly sold contingent coupon note is the guaranteed coupon.

The possibility of earning an extra premium called “step income” was an additional feature characteristic of this structure, which has been sold for many years by BofA under the “Step Income” brand across its platform.

Prior to this deal, BofA Securities, Inc. has priced four STEP Income offerings this year. Two were issued by Royal Bank of Canada and two by Bank of Nova Scotia. RBC used Netflix, Inc. in one of its deals and FedEx Corp. in the other. Scotia priced one offering on Microsoft Corp. and the other on Goldman Sachs Group, Inc.

Those four deals combined amounted to $70 million in notional. Barclays’ recently priced deal is the largest STEP Income offering so far this year.

A special kind of bull

Despite the bullet nature of the notes, investors should stick to income as the rationale behind the trade.

“You can’t look at this product as a growth play. It’s pure income,” the market participant said.

The maximum return is the sum of the guaranteed interest rate and contingent step payment, or 10.9%. Once the stock increases above 10.9%, the note will underperform the share price of Amazon.

“You can’t be bullish on Amazon because you don’t want it to be up more than 11% in the next year. That’s a very muted outlook for a stock that has gone up more than 30% in the past year,” he said.

“At the same time, you’re taking all the downside so you have to be bullish enough to bet that the stock won’t go down.

“If you think it’s going to range trade and be slightly up, that’s a good play. Otherwise, you should be buying the stock outright.

“I’m not saying it’s a bad deal. But buy it for income, not to outperform the stock.

“Obviously, it will work for some people. That’s the great thing about structured products. You get to choose what matches your view.

Fairly priced

A buysider was satisfied with the risk-reward.

“It has a good coupon, but I wouldn’t say it doesn’t have risk,” said Andrew Valentine Pool, main trader at Regatta Research & Money Management.

The risk, he said, lies in the current valuation of the stock.

“The stock price over the past 10 months is substantially higher than the stock was over the previous two years.

“If we have a pullback maybe a year from now, it could easily be subject to a 15% loss.

“On the other hand, you’re getting properly compensated in my view, based on the median price of the stock in the past 10 months.

“A 10.9% maximum return... I think that’s fair.”

The notes (Cusip: 06747R170) will settle on Friday.

BofA Securities, Inc. is the agent.

The fee is 1.5%.

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