Barclays’ $15.55 million contingent yield notes on indexes feature daily coupon observation

By Emma Trincal

New York, Oct. 28 – Barclays Bank plc’s $15.55 million of trigger callable contingent yield notes due April 22, 2022 linked to the worst performing of the MSCI EAFE index, the Russell 2000 index and the S&P 500 index presented an unusual feature with its daily coupon observation, sources noted.

Each quarter, the notes will pay a contingent coupon at an annual rate of 9.45% if each index closes at or above its coupon barrier level, 70% of its initial level, on each day during the relevant quarterly observation period, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be callable at par of $10 plus any coupon on any quarterly observation date other than the final one.

If the notes are not called and each index finishes at or above its downside threshold level, 65% of its initial level, the payout at maturity will be par plus any coupon. Otherwise, investors will lose 1% for every 1% decline of the least-performing index.

Any day observation

“It’s a classic callable contingent coupon note,” a market participant said.

“The barrier on the coupon is observed any day. That’s more risk, but I’m not sure it makes much of a difference if it is any day or at the end of the quarter.”

One way to verify this would be to compare this note with a similar one carrying a typical one-day observation date per quarter. Strangely no deal last week permitted such fair comparison.

On the other hand, several offerings were spotted displaying the same and relatively unusual “daily coupon observation.”

For example, UBS sold on behalf of Morgan Stanley Finance LLC $10.67 million of three-year trigger callable contingent yield notes with daily coupon observation. The 10% coupon, based on the worst of the S&P 500 index, the Russell 2000 index and the Euro Stoxx 50 index, will be paid on the basis of a daily observation coupon barrier set at 65%.

Stepping down

The market participant said the Barclays notes were “not a bad deal,” as they offer “a good alternative, bond-like return.”

But he would have shortened the tenor.

“Why not go for a nine month or a 12 month? The volatility curve is inverted. You get more vol. as you stay on the short end of the term curve,” he said.

The volatility term structure represents the impact of the length of an option contract on the implied volatility of the option.

When the term structure of implied volatility is “inverted,” implied volatilities tend to be higher for options with a nearer expiration date.

“Making it shorter would be an easier way to get a higher coupon,” he said.

Another possible improvement in his view would be to replace the issuer call with a step down autocall, allowing the call level to progressively move lower.

He gave an example: the trigger level could be at 100% of the initial price after three months, stepping down to 95% after six months to finally decrease by an additional 2.5% on each following quarter.

“Those step down can be really attractive. People like the fact that they can get called in a declining market,” he said.

Underlying basket

Ed Condon, portfolio manager at Bluestone Capital Management, said he was intrigued by the use of the daily observation for the coupon.

“It’s interesting that they’re doing that.

“There must be a pretty big difference in the size of the coupon between that and using the normal version, which is a single day per quarter. Otherwise why would you go through that extended risk? There’s got to be a pretty big pick up,” he said.

Commenting on the underlying, he said the use of the three indexes was “not uncommon,” although the Euro Stoxx 50 index tends to be more widespread than the MSCI EAFE index.

The MSCI EAFE index tracks the performance of developed markets at the exception of the United States and Canada.

Issuers may offer exposure to the MSCI EAFE index as a proxy to European equities since 60% of this index consists of European stocks.

The Euro Stoxx 50 tracks the performance of the euro zone equity market. Lately, this benchmark has been mostly used as a stand-alone underlying. When used in a worst-of, it tends to be paired with the Russell 2000 index, according to data compiled by Prospect News. The goal is perhaps to increase the dispersion risk, which will prevail between a European large-cap index and a U.S. small-cap benchmark.

“I’m sure a lot of outstanding issues are using the Euro Stoxx. The issuer was probably looking to diversify their own book by using the EAFE,” said Condon.

Due diligence

Investors in order to get a yield nearing 10% have to take some risks and sometimes, assessing the risk is the main challenge, he said.

“This deal is for income, and the 9.45% income stream you’re getting is significant,” he said.

“The alternative to try and generate a 9% or 10% coupon would not only be risky...it would make the understanding of the risk very difficult.

“At least, with notes linked to equity indices, you understand what you’re dealing with.”

Examples of alternative investments could be private placement funds or “SPAC deals,” he said.

A special purpose acquisition company (SPAC) also known as a “blank check company” is a development stage company that has no other purpose than raising capital to engage in a merger or acquisition with other companies.

Beware junk bonds

“Anything that can generate substantial cash flow tends to be quite opaque. You have to go out into the marketplace, do quite a bit of due diligence to identify the risks.

“I think I can look at equity indices and easily understand what the risks are.”

Trying to generate higher coupons with high-yield bonds seems like a natural alternative, but it would be a mistake, he added.

“You might be able to generate a high cash flow with a high-yield bond, but that’s junk credit. I don’t think now is a good time to take on high-yield junk credit as we’re going through this Covid crisis with potential increases in evictions, mortgage defaults and bankruptcies over the next six to nine months,” he said.

UBS Financial Services Inc. and Barclays are the agents.

The notes priced on Oct. 19 and settled on Oct. 22.

The Cusip number is 06747K316.

The fee is 1.25%.

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