Barclays’ Super Track notes tied to Euro Stoxx show high return score, but pricing disappoints

By Emma Trincal

New York, July 25 – Barclays Bank plc’s Super Track notes due Feb. 1, 2018 linked to the Euro Stoxx 50 index exhibit a good risk-adjusted return rating, but the high yield paid by the underlying index makes for a less satisfying valuation, said Tim Mortimer, managing director at Future Value Consultants, commenting on his firm’s research report on the product.

The payout at maturity will be par plus at least 1.45 times any index gain. Investors will receive par if the index falls by up to 25% and will be fully exposed to losses if the index finishes below the 75% trigger level, according to a 424B2 filing with the Securities and Exchange Commission.

“The 1.45 times leverage at first appears to be very attractive. Given that the note is uncapped, this product is designed for a quite bullish investor,” Mortimer said.

Riskier

Future Value Consultants use a series of scores to measure risk, risk-adjusted return and valuation or pricing.

The riskmap is Future Value Consultants’ measure on a scale of zero to 10 of the risk associated with a product with 10 as the highest level of risk possible. This rating has two components: market risk and credit risk based on the same scale.

The notes have a relatively more risky profile than comparable structures. They were given a 3.93 riskmap versus an average 3.37 riskmap for products of the same type, according to the research report.

Both the market riskmap and credit riskmap are higher than average at 3.22 and 0.71, respectively. The average market riskmap for leveraged return notes – the category under which this product falls – is 2.78. The average credit riskmap is 0.59.

“On the market risk side, you could say that given the volatility of the Euro Stoxx, the 75% barrier is not that deep,” Mortimer said.

“A 60% or even 50% barrier, which you can find with this index depending on the maturity, would have helped reduce the market riskmap.”

For the credit risk, the rating takes into account both the issuer’s creditworthiness and the duration.

At 68 basis points, Barclays’ five-year credit default swap spreads are relatively tight compared to some U.S. banks such as Morgan Stanley and Bank of America (both at 72 bps) and Goldman Sachs at 77 bps, according to Markit.

“The credit risk here is definitely affected by the maturity. In this leveraged return category of product, durations are usually shorter, which explains why we see a bit more credit risk here despite the relatively good credit of the issuer,” he said.

Good return score

Future Value Consultants measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions: neutral assumption, bull and bear markets and high- and low-volatility environments.

A risk-adjusted average return for each assumption set is then calculated.

The return score is calculated based on the best among the five return scenarios, which would be bullish for this particular product, he said.

The product has an 8.47 return score, compared with the 7.76 average for the category.

“When you get the bull scenario, which is what we have here, you get a pretty good score since it’s got an uncapped return with the leverage,” he said.

“Even if the 75% barrier is not very low, it doesn’t really matter in this particular market assumption, which explains why we get a high return score. The no-cap is key for high return scores under a bullish scenario.

“On the other hand, the price score is lower as we use different market assumptions for the computation of the return score and the price score. The breach of the barrier is more likely to occur under a neutral scenario, which is where the pricing comes in.”

One of the particularities of the product is the discrepancy between its healthy return score and its less-attractive price score, he said.

The price score estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor as the issuer has spent more on the options.

Measured on a scale of zero to 10, the product has a price score of 6.31, compared with a 7.50 average for the product type.

Mortimer explained why.

“When we price a deal – in other words, when we measure how much is spent on the assets – we keep the neutral assumption. We use the same basis for all the pricing on all of the deals we rate. How much does the bank spend on buying the options, and how little do they get in the fees: that’s the value,” he said.

“The return score methodology is entirely different because we choose the best market scenario for each product. We do that in order to make sure that someone who will select the product has very good reasons to make that call. The return score will be a function of how reasonable it is for someone to assume that their bet is correct. By default, we use the most favorable market environment.

“Whether this product is priced competitively is a different question. It appears not quite. A little bit more leverage would have helped.”

Price score and dividends

Mortimer said that there is a relationship between value and underliers that pay high dividends. Investors in a structured note must forego dividends. The higher the dividends, the lower the price score of the notes.

“Issuers may offer attractive terms, higher leverage multiples to offset the opportunity cost associated with the non-payment of dividends. But if it does not fully compensate you, the value of the product will suffer,” he said, adding that this product offers an illustration of his point.

“We see the Euro Stoxx 50 quite a lot. It’s a popular underlying index. It pays a pretty good dividend, which allows issuers to show appealing terms,” he said.

“One way to see where the value is would be to find out at what point the product is going to be outperforming the index.

“The Euro Stoxx pays a 3% dividend yield. Over three and a half years, that’s a 10.5% return from dividends. The notes pay a 1.45 times leverage. We need to have the index grow by a little bit more than 23% over the period for this product to achieve breakeven against the tracker with dividends.”

He divided the total percentage amount of unpaid dividends over the life of the notes by the excess participation rate over 100%.

In this case, if the index grows by 23.33% over three and a half years, the leveraged payout will generate a 10.5% return, which equals the dividends.

“At first glance, 1.45 as a multiple sounds pretty good, but you have to compare this with the dividends,” he said.

“You need 23.3% in return over three and a half years to just match the return with dividends, which is not nothing.

“Then at that point, and only at that point, you are better off than having the tracker.”

The higher dividend yield explains in part the lower value seen with these notes as measured by the price score.

“You’re missing more in dividends; the opportunity cost is greater for you,” he said.

“You’ll see better participation rates with high-dividend indexes because you have more money to spend.

“The 1.45 times leverage looks good, but you’re still coming out with a low price score because of the high amount of dividends you have to give out when you invest in the notes.

“If you had the same terms on the S&P, which has over one percentage point less in yield, you would have a much higher price score.”

Future Value Consultants gives its general opinion of a deal by averaging the return score and the price score, which creates the overall score. The notes have a 7.39 overall score. The average for notes of the same product type is 7.63.

“The low price score dragged down the overall, but you’re still close to average because of the good return score. One score offset the other. You end up with a decent product at the end,” he said.

Barclays is the agent.

The notes will price Monday and settle Thursday.

The Cusip number is 06741UFZ2.

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