Barclays’ leverage notes with 95% floor on indexes seen as timely in current market conditions

By Emma Trincal

New York, July 12 – Barclays Bank plc’s 0% notes due Aug. 4, 2021 linked to the lesser performing of the Russell 2000 index and the S&P 500 index offer investors an attractive risk-adjusted return at this late stage of a bull market, buysiders said.

If each index closes at or above is initial level, the payout at maturity will be par plus 1.5 times the gain of the worse performing index up to a maximum return of 24% to 26%, according to a 424B2 filing with the Securities and Exchange Commission.

If either index falls, the payout will be par plus the return of the worse performing index with a minimum payout of 95% of the initial price.

Best case scenario: investors may earn up to 24% to 26% at the end of the three-year period. Worse case: they will not lose more than 5% of their principal due to any market downturn. This balance between risk and reward is attractive, advisers noted.

Recent trend

A number of quasi fully protected notes offerings have hit the market over the past two months for the first time in years as interest rates are rising.

Principal-protected notes combine a zero-coupon bond with options. The greater the discount (induced by higher rates), the more money there is to purchase the derivatives.

Just a year ago, full or nearly principal-protected notes had to be structured on terms longer than five, sometimes six years. Now the products with 90% or 95% protection can be made on shorter tenors, according to data compiled by Prospect News.

Several principal-protected deals with 5% to 10% at risk have come out in the past two months. The majority were issued by Morgan Stanley. Barclays did some too. Those were structured on a single underlier.

The upcoming Barclays deal appears to be one of the first using a worst-of payout, based on recently compiled data.

Advisers did not object to the two underliers, especially given the high correlation between the large-cap and small-cap indexes. The appeal of having market losses capped at 5% of principal prevailed over concerns about dispersion risk.

Likely to be popular

“This is the first I’ve seen. I kind of like this huge floor,” said Steve Doucette, financial adviser at Proctor Financial.

“A client would love that 95% protection feature, at least those willing to live with the cap.”

Perhaps a growing number of clients are becoming less reluctant to cap their potential gains, he noted.

The structure of the notes would make the cap relatively easy to reach even in a slow market, he added.

If the cap is set at 25%, which is at the midpoint of the range, the worst-performing index would only have to be up 5.25% in order to achieve the maximum return.

“Here we are, nine years into the bull market...Three years out, do we really expect to make more than 5% a year?”

The cap based on the 24% to 26% range represents on a compounded basis a 7.5% to 8% annualized return.

If he had to modify the structure, Doucette said he may want to look into reducing the amount of protection aiming at raising the cap.

“I do kind of like the note. But I would probably give up some of the protection and try to get the cap as high as I can. It would be interesting to find out how much higher the cap could be with a 90% floor.

But this adjustment would be for his most bullish investors.

“A lot of clients would probably be happy the way it is now,” he said.

Cap versus floor

Matt Medeiros, president and chief executive at the Institute for Wealth Management, said the structure was very attractive at this stage of the bull market.

“I like the protection very much,” he said.

“I think during the term of the notes, we’ll have more volatility than we’ve had in the past couple of years.”

The payout based on the lesser performing of two assets was not his preference. But the terms made up for this disadvantage.

“I typically don’t like worst-of strategies. But in this case the 95% downside protection is so compelling, it’s not a deal breaker,” he said.

Capping the upside at 7.5% to 8% a year was also acceptable.

“I wouldn’t worry about the cap. It’s actually a fine return.

“There is a good chance we’ll be against the cap, it’s true. But it’s OK given how we’re being compensated with the protection.

“I like the note in this environment.”

Barclays is the agent.

The notes will price on July 31.

The Cusip number is 06746XHP1.

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