Barclays’ phoenix autocalls tied to Nasdaq, Dow seen as being on lower end of risk spectrum

By Emma Trincal

New York, Nov. 16 – Barclays Bank plc’s phoenix autocallable notes due Nov. 29, 2019 linked to the lesser performing of the Nasdaq-100 index and the Dow Jones industrial average offer a number of risk-reducing features making the notes more appropriate for conservative investors as long as they are aware that a barrier may lead to significant losses, said Suzi Hampson, head of research at Future Value Consultants.

The notes will pay a contingent quarterly coupon at an annual rate of 6.5% to 7.5% if each underlying asset closes at or above its 75% coupon barrier on the observation date for that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par plus the contingent coupon if each asset closes at or above its initial price on any call valuation date after six months.

The payout at maturity will be par unless either underlying asset ever closes below its 75% trigger level during the life of the notes, in which case investors will be exposed to any losses of the worse performing index.

More conservative

“It’s quite a defensive product,” she said.

“The maturity is shorter than usual.

“You can kick out, which by definition removes the risk of losing principal.

“The coupon is not that high. That’s the kind of low coupon that leads to a low barrier.”

The issuer however had to find ways to price the 75% barrier.

“On a short maturity, you have to generate the return somehow,” she said.

Issuers can always use a volatile underlying, for instance, such as a single-stock.

The issuer in this case used another alternative.

“If you want broadly diversified-index exposure, you generally have to use a worst-of, which is what they did with this product,” she said.

Phoenix

One attractive aspect of the notes for more risk-averse investors was the relatively benign impact of the worst-of.

“Worst-of will always add more risk. Here however the risk is contained because they chose highly correlated indices,” she said.

Investors cannot be called during the first six months. But they can collect the coupon during that time.

This is the advantage of the so-called “Phoenix autocallables,” which allow the payment of income even when a call does not occur, she said. But investors should not perceive the notes as a pure income play.

“Sometimes people come to these products seeking real income expecting to get the full 7% coupon.

“The most likely scenario is half of that,” she said.

“It doesn’t seem like a very high return. But you have a low risk barrier. You also have greater chances of getting paid, which is what some investors want most.”

Product specific tests

To illustrate her description of the structure, Hampson used the stress testing report her firm ran for the product.

She used a 7% hypothetical contingent coupon at the midpoint of the range.

Each report contains a total of 29 sections or tests, which can be customized in any combination.

One table named “product specific tests” displays probabilities of various outcomes based on the structure type. With this kind of product, the outcomes include among others barrier breach, probabilities of call on the first date (after six month), second and third date as well as chances of getting paid one, two, three or four coupons.

The table features five distribution assumptions. They represent five market scenarios, which are based on volatility and hypothetical growth rates for the underliers. Those are bull, bear, less volatile and more volatile. A neutral scenario is the basis of the simulation in all reports. It reflects standard pricing based on the risk-free rate, dividends and volatility of the underlying.

Barrier breach

“What we notice first is the low chances of breaching the barrier at maturity,” she said.

The “barrier breach” outcome on the table displayed the same 6.78% probability for both the bull and the less volatile scenarios. In contrast the risk of breaching the barrier amounted to 17.45% and 16.05% for the bear and more volatile scenarios, respectively. The probability in the neutral scenario was 11.71%.

“We’re seeing the usual distribution across the various market types,” she noted.

“The bull scenario looks good. The bear...less so. The more volatile one is comparable to the bear. The less volatile is just as good as the bull,” she added.

These results illustrate one of the important differences between autocalls and growth products, she added.

“With a note like this one, you really don’t need the underlying to go up. You just need it to stay relatively stable, which is why both the bull and the less volatile scenario bring the best outcome. You are very unlikely to breach the barrier in those two market scenarios. In fact, the probability is exactly the same.”

Those results also pointed to the modest risk associated with the product compared to other similar notes.

“We can see that the worst-of doesn’t introduce that much risk here. We owe this result to the high correlation between the two U.S. indices,” she said.

Call points

Looking at the probabilities of calls occurring on one of the three dates, she found that the notes followed the regular pattern of any autocallable structure: the chances of a call are disproportionally higher on the first call date or “point 1,” per the firm’s terminology.

“It’s 50% for the neutral and 57% for the bull. Even in the worst scenario, the bear, your chances of calling at point 1 are 41%,” she said.

The probabilities drop significantly for “call at point 2” and “call at point 3” with an 11% chance and 5% probability, respectively, in the neutral environment.

Barrier use

The report also allows its users to estimate the “value” of the barrier, which corresponds to a situation in which the worst-performing index sees its price finish between 75% and 100%.

“If the probability is high, it means the barrier is doing its job, which is a good thing otherwise there’s no point in having it,” she said.

The probability assigned to this “barrier zone” is calculated by subtracting the “barrier breach” probability from the “no call occurs” probability.

The “no call occurs” outcome shows in the neutral scenario a 34.63%, which guarantees that the index will finish negative.

By subtracting the barrier breach probability of 11.71% from this latest figure, which represents all negative outcomes, one gets to find out that investors will benefit from the barrier 23% of the time, she explained.

Getting paid

“The good news is you’re not necessarily going to be sitting there just to get par back at maturity. The chance of getting zero coupon is negligible,” she said.

“This is due to the nature of Phoenix autocalls. It’s an income product. You don’t need to kick out to get the return.

“A quarter of the time, you’ll get four payments.”

The table illustrated her point based on mutually exclusive outcomes for one, two, three and four coupons paid.

The highest probability of 53.95% goes to two coupons paid. The four coupon payments occur 24.43% of the time. There is only a 3% chance of getting just one payment.

“Investors are not getting a very high coupon. But the chances of getting income are quite high,” she said.

“This product is not designed for bullish investors. There are better participation notes for that.

“But for those who want to maximize the chances of receiving income without taking on too much risk, this seems to offer a reasonable compromise,” she said.

Barclays is the agent.

The notes will price on Nov. 27.

The Cusip number is 06746XWY5.

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