Barclays' digital notes on Dow offer buffer, no cap, but tenor, no leverage may be drawbacks

By Emma Trincal

New York, July 11 - Barclays Bank plc's 0% buffered digital plus notes due July 31, 2017 linked to the Dow Jones industrial average offer a minimum digital payment and no upside cap coupled with a buffer, which make the deal appealing, according to sources.

However, the longer term of the notes, during which investors do not receive dividends, and the absence of leveraged upside can be seen as drawbacks, they said.

If the index finishes at or above the initial index level, the payout at maturity will be par plus the greater of the index return and the to-be-set digital return of 11% to 12%. Investors will receive par if the index falls by up to 15% and will lose 1% for every 1% decline beyond 15%, according to a 424B2 filing with the Securities and Exchange Commission.

For Jim Delaney, portfolio manager at Market Strategies Management, the uncapped upside and also the 15% buffer are the most attractive terms of the deal.

"It's a four-year [note], so you have this credit risk exposure. But Barclays is not going to go away. Its five-year credit default swaps are trading at 149 basis points. Anything below 100 is better, but still ... this isn't bad," he said.

Good for bulls

"I am bullish. The market will have a week or two-week periods like we just had. But we are in a long-term bull market, not in a long-term bear market," Delaney said.

"I think the market will be up at least 12% or higher in the next four years. So I'm not worried about the buffer. I like the fact that there is no cap. That's what makes the deal attractive to me.

"In my view, you're not going to need the buffer and you're going to exceed the digital. So it's nice not to have a cap."

The buffer, however, is helpful to manage risk, he said.

"If I'm wrong and the market trades flat, finishing under 12%, at least I'm getting something. I am getting 12% minimum, which is about 3% a year.

"If I'm very wrong, I know that I have 15 percentage points coming back to me."

As with most structured products, holders of the notes will not receive dividends. The Dow pays 2.23% in dividends, so investors have to forgo this amount over the term of the notes.

"If the index is flat, it's pretty much a wash. You get the 3% per year digital, but it's not much more than what you're losing in dividends," he said.

"But with the 15% buffer, you get a little bit more.

"Bottom line, I think you're getting a pretty decent protection without being penalized by a cap if the market continues to rise, which is what I expect in this four-year time horizon."

Secondary pricing

For Steven Foldes, president and chief executive of Foldes Financial Management LLC, the duration of the notes and their payout on the upside are more problematic.

Foregoing dividends - 2.23% a year, or about 10% with compounding over the term - is not very significant thanks to the digital payout, he said.

"What you lose by giving up your dividends you're getting it back. You have a 15% buffer, but you're giving up approximately 10%," he said.

"The reason I don't like this note is because four years is a long time for a structured note."

Investors may not want to hold the securities until maturity, he explained.

"It would be interesting to know how close to the Dow Jones the notes would be pricing if you decided to redeem early. You need to ask that question to Barclays. This is most important for us. We do sell before maturity," he said.

"The issue is not whether the issuer will buy back the notes but rather at what price. Will you get a hundred percent of the Dow Jones appreciation after two or three years? Or will they take a haircut by virtue of selling early?

"If for instance the index is up 15% on the first year, will the notes show 15%, 9% or 12%?

"This is our first question from the client's perspective. We like to see the notes reflect the value of the index."

The missing piece

Foldes also brought up another concern: the one-for-one upside participation beyond the digital level.

While some investors do not want to see their potential gains capped even if it means having no leverage, others, such as Foldes, would choose the exact opposite.

"I would prefer a good cap with leverage rather than having no leverage and no cap," he said.

"There is no cap here, which is nice. But typically we like to have leverage on the upside.

"We tend to get 10% to 15% protection on the downside and one-and-a-half times to three times on the upside.

"We bought a three-year note with a 96% cap. It was tied to a U.S. real estate equity fund. We understand that you can't get similar terms with deals tied to the Dow Jones or the S&P. But this note would not match our requirements."

The fees are 3%, according to the prospectus.

"Obviously the fees are high. You give up a good dividend. And four years is a long time," he said.

The notes (Cusip: 06741TYJ0) are expected to price July 26 and settle July 31.

Barclays is the agent.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.