Barclays’ $121.2 million digital notes linked to S&P 500 rank No. 8 in size for year so far

By Emma Trincal

New York, May 4 – While not among the blockbusters, Barclays Bank plc’s $121.2 million issue of 0% digital notes due May 5, 2017 linked to the S&P 500 index is still in the top 10 list for the year, according to data compiled by Prospect News.

If the index return is at least negative 15%, the payout at maturity will be par plus 4.84%.

If the index return is less than negative 15%, investors will lose 1.1765% for every 1% that the index declines beyond 15%.

The offering was the largest one to price last week.

Sources noted that bigger deals tend to be leveraged products. Digital notes are usually not among the largest offerings, but there are some exceptions.

Second digital in size

Barclays issue is the second-largest digital deal this year so far after Credit Suisse AG, London Branch’s $270.66 million of digital notes linked to the S&P 500. This issue, which was sold in March, remains the second biggest deal of the year among all structures.

It has many similarities with the structure of Barclays’ deal. Although longer in duration by six months and paying a different coupon of 9%, it also references the S&P 500, has a 15% geared buffer and pays the digital if the index finishes above the 85% threshold.

Most of the 10 deals other than those two are leveraged return notes. The top one by far is Goldman Sachs Group, Inc.’s $1.07 billion issue, which priced at the end of January. It is a one-year capped note linked to a basket of three foreign equity benchmarks and was distributed by JPMorgan.

Trendy structure

Sources predicted that digital structures offering a positive return when the market is down within a range and not just when it is flat or higher than its initial level are likely to succeed in the current market environment, especially when they come with a buffer.

“If you expect the market to be slightly down, you can make a profit if your view is correct,” a market participant said.

“The gearing is not a bad idea. It gives you a better cap and better terms.”

Risk versus reward

The 4.84% digital return over one year cannot be compared to what investors would get from a typical digital note, one that only pays if the index is up at maturity, he said.

“It’s not about the coupon. What you want to figure out is, what are the probabilities I’m getting this coupon?” he said.

“For many investors now, it’s better to have an 80% chance of getting a 4.8% coupon than being offered a much higher coupon that you can’t get.

“Investors realize that the market is toppish. Most of the rally has been fueled by quantitative easing policies in the world, in particular in the U.S.

“We’re now at pretty high levels. It does make sense to limit your upside, reduce your risk and increase your chances of getting paid.”

Geared buffer

Andrew Valentine Pool, main trader at Regatta Research & Money Management, said he understands most of the reasons investors would have heavily bid on the trade.

“This market is probably going to stay within a range, so it makes sense. I can see why it was a huge seller,” he said.

The level of risk associated with a geared buffer is a function of the underlying, he noted.

“It depends if it’s tied to an overbought or oversold index. Right now, the S&P is a little bit overbought.

“But with 15% we would be comfortable for a small position.

“At 10% we would probably want to give it more thought, although a 10% buffer with no gearing might be a possibility.”

The length is your friend

Still, Pool said the tenor in his view is a significant risk factor.

“I was actually surprised about how big it was,” he said about the deal.

“Recently we bought plain-vanilla notes, two from JPMorgan and one from BNP. What they have in common is their length. These are four-year, five-year notes.”

Pool said he prefers to invest in longer tenors right now, citing two main reasons.

“First, we purchased a lot of notes two or three years ago. They mature this year or next year. We need to ladder it,” he said.

The second reason reflects risk concerns.

“We don’t feel comfortable investing for one year right now, as the market faces greater chances of a correction.

“There should be enough time for an investment to recover. At least if you invest in a four- or five-year note, you may be able to ride out a big pullback.”

Barclays is the agent.

The notes (Cusip: 06741V2J0) priced on April 26.

The fee was 0.75%.

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