Barclays’ $10 million fixed rate autocalls on JPMorgan may be redeemed too soon, advisers say

By Emma Trincal

New York, April 20 – Barclays Bank plc’s $10 million of 18% fixed coupon autocallable securities due April 20, 2021 linked to the common stock of JPMorgan Chase & Co., offer the benefit of a fixed and high double-digit coupon rate, but investors may not consider it as a traditional source of income due to the monthly autocallable feature, which aggravates the reinvestment risk, advisers said.

Interest is payable monthly, according to a 424B2 filing with the Securities and Exchange Commission.

If the stock closes at or above its initial price on a monthly determination date, the notes will be automatically called at par plus the coupon. The first automatic call may occur as early as May 15.

If the stock finishes at or above the 80% downside threshold level, the payout at maturity will be par plus the final coupon. Otherwise, the payout will be a number of JPMorgan shares equal to $1,000 divided by the downside threshold level or, at the issuer’s option, a cash amount equal to the value of those shares.

Jerry Verseput, president of Veripax Financial Management, said the barrier should provide enough protection.

Extra cautious

“You would have to revisit the lows of March to breach the barrier. But that’s OK because since the 18% is not contingent, you have another 18% to protect your downside,” he said.

But betting on a single stock and sector is not without risks.

“The danger since your underlying is a bank stock is if the banks come under pressure,” he said.

Part of the pressure was the result of banks adopting conservative models.

“The reason why banks had poor earnings last week is because they raised their loan-loss reserves. They assumed a lot of people were going to default. That’s why their profits dropped so much.”

The six top banks reported plummeting profits last week. JPMorgan’s net income was down 69%.

When JPMorgan reported its earnings last Tuesday, its share price shed 5.45%.

“It’s not such a big drop. All the bad news has been baked in,” he said.

“JPMorgan, the largest U.S. bank, is kind of a proxy for the others. It could drop to its recent lows again. But you have the equivalent of an 18% buffer.

Guaranteed rate, not income

“This might not be a bad kind of income-generator.”

Except that investors should not totally rely on the notes for income, he warned, stressing the high likelihood of an early call.

“Better not be dependent on getting the 18%,” he said, arguing that the note does not offer any call protection.

Investors could see the note called in May pocketing only 1.5% in return.

“You shouldn’t adjust your lifestyle based the idea that you’re going to collect all the payments.

“There is definitely reinvestment risk,” he said.

But for Verseput, such risk was offset by the high double-digit return.

“Even if you get called in the first month or two, you’re still getting a pretty high return. 18% annualized is still 18% for however long you can make it.

“You just can’t rely on it for income.

“But if you’re comfortable with the pressure banks are facing in this crisis, it’s probably a good opportunistic play.”

Strike price

Carl Kunhardt, wealth adviser at Quest Capital Management, said he would not invest in the notes for several reasons.

One was about the determination of the strike. He noted a discrepancy between the closing price of the underlying at the stated pricing date and the initial underlying value, or strike price on the deal.

The notes priced on April 15 with a strike price of $95.87, according to the prospectus. However, the stock on that day closed at a much lower level of $90.79.

The issuer did not catch investors by surprise: in both the offering and the final documents, it stated that: “the initial value is not the closing price of the underlier on the pricing date.”

Still, Kunhardt said he did not feel comfortable with that.

“That in and out itself is a red flag to me. I don’t like not having any clue of when and how they’re going to be pricing the deal,” he said.

“They had their earnings and then the stock dropped. We don’t really know on which basis they priced it,” he said.

To be sure on April 14, the day of the earnings announcement, volatility was much greater than on the next day set for pricing. The stock opened on April 14 at $101.02 and closed at $95.50, which was relatively near the strike price.

But the next day, the stock fell by nearly $4 at the open and remained in a tighter range, closing at $90.79.

Normally, the initial value of an underlying is set at the closing price of the pricing date. In such case, the underlying’s initial value would have been $90.79, or more than $5 lower than what turned out to be the actual strike price.

Issuers always have the flexibility to price under better conditions as long as they disclose it, which was the case in this offering. But Kunhardt said he has not seen this done before and did not feel comfortable with the process.

Another drawback was the nature of the underlying itself.

“I don’t like single stocks on structured notes, even if it’s a stock like JPMorgan,” he said.

Risk-reward

Looking at the structure, Kunhardt had more objections.

“It’s a very attractive yield. But I don’t like the risk return. If you breach the barrier you can lose your entire principal,” he said.

The current coronavirus-induced economic crisis has made the banking sector riskier than usual, he added.

He cited as an example Rep. Ilhan Omar (D-Minn.), who on Friday introduced a bill to cancel rent and mortgage payments nationwide for all Americans.

“What happens if suddenly people stop paying their rents or mortgage? The banks would be hit with massive losses,” he said.

“If the stock is down and breach the barrier, you may be cushioned by the coupon. But it’s still an opportunity cost.

“Granted one year is not a long time. But I’m not making any money and I can still lose a lot of money.”

Anchoring bias

On the other hand, while the return is attractive, investors would be capped if the economy rebounds, which could certainly happen within the next year.

“If JPMorgan is up, I’m going to miss the rally and the notes will get called right away,” he said.

For this adviser, getting an 18% annualized return when collecting only a few months’ worth of coupon does not reflect reality.

He used the behavioral finance term “anchoring bias” to contest the notion that getting even one or two monthly coupons is the same as achieving an 18% annualized return.

“It’s only 18% if you get one coupon each month for a year. I don’t care if you call it 18% annualized.

“You’ll never get 12 coupons.

“Even if it was tied to an index and not a stock, I wouldn’t do it because of that early call,” he said.

Barclays is the agent with Morgan Stanley Wealth Management as a dealer.

The notes settled on April 20.

The Cusip is 06741WGK0.

The fee is 0.2%.

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