Barclays’ $233,000 callable notes on S&P, oil fund show unusually high contingent coupon

By Emma Trincal

New York, March 31 – Barclays Bank plc’s $233,000 of callable contingent coupon notes due March 23, 2023 linked to the S&P 500 index and the SPDR S&P Oil & Gas Exploration & Production exchange-traded fund offer a very high contingent coupon and deep barrier. Yet and despite the sharp drop in the market, sources were not willing to take the risk with the notes as they believe the bear market is far from over.

The notes pay a semiannual contingent coupon at an annualized rate of 49% if each underlying component closes at or above its coupon barrier level, 65% of its initial level, on the observation date for that period, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par unless either component finishes below its 65% barrier level, in which case investors will be fully exposed to any losses of the worse performing component.

The notes are callable at par plus any coupon on any contingent coupon payment date.

Issuer call

“I think your best outcome would be to be called in six months with a 49% annual return,” said a market participant.

However, the call is discretionary, and investors are unable to predict its occurrence, he said. But if the price is far from the barrier level on the upside, the issuer will be more likely to call, according to the prospectus.

Some of the attractive terms include the high potential return and the six-month call protection, guaranteeing that half of the annual return will be paid if the notes are called on the first semi-annual coupon payment date.

Despite those positives, this market participant did not like the time frame and the price level of the S&P 500 index.

“The three-year maturity is not ideal, and having the S&P 500 increases the risk,” he said.

“It’s almost a given that the worst-performing asset will be the large-cap benchmark, not the ETF.”

Overvalued S&P

The SPDR S&P Oil & Gas Exploration & Production ETF is at a multi-year low.

“It’s very cheap. It’s the one that has the least risk. I wouldn’t worry about it going lower and certainly not dropping another 35%,” he said.

But this market participant does not believe the S&P 500 index is anywhere near its bottom whether in time or based on price even though the benchmark has already lost 35.4% from its peak on Feb. 19 to its recent low on March 23.

“We’ll have recovery rallies, the typical bear rallies, like what we saw last week. But the S&P remains sky-high even since the drop if you compare it to what its fair value should be,” he said.

Based on the Shiller PE ratio, he estimates the fair value of the S&P 500 index to be around 1,700.

The Shiller indicator is a price-to-earnings ratio based on average inflation-adjusted earnings from the previous 10 years.

Long bear

The S&P 500 index closed at 2,304.92 when the deal priced last week.

“It’s not far from the recent low. But we have much further to go on the downside,” he said.

If the benchmark had to hit what he considers its “fair market value,” a further drop of more than 25% would be expected.

That’s when the time factor comes into play.

“We’re not going to have a quick recovery. It’s not going to be a short bear market because this is a bear market that follows a historically long bull market,” he said.

Historic precedents

Therefore, unless the notes get called, the three-year term, in his view, is a significant risk factor.

That’s because the downtrend could last several years and be deep.

He pointed to the 1929-1932 bear market, which saw the Dow Jones industrial average fall by 89.2% from Sept. 3, 1929 to July 8, 1932 in different drops interrupted by rallies.

On a smaller scale but lasting longer than the average bear cycle, the bear market of 2000-2002 recorded a 40% drawdown.

“The market will take a long time to recover because it was at historic high levels of valuation and because we had the longest bull market in history,” he said.

“The coupon of 49% a year is very good and so is the barrier.

“But if the notes are not called, the risk at maturity is real even with the 35% barrier simply because the three-year length is not ideal at all.”

Not business as usual

A financial adviser expressed doubts about the soundness of the investment in today’s market environment.

“It sounds very attractive. I’m going to give you 24% in six months if neither one of those two things fall more than 35%,” he said.

“What are the odds since we’re already down 30%? It seems unlikely. You might roll the dice.”

But this adviser would not “roll the dice.”

“In this environment dominated by emotional reactions to a pandemic, with more questions than answers and the media’s deluge of bad news making this market even more emotional, I think we have more testing to go.

“I’m not a bear, don’t get me wrong.

“I’m bullish by nature.

“But this is not a normal environment.

Recession risk

“It’s not just the pandemic but also the policies that are being put in place. When you start shutting down businesses and put people out of work, you can’t really predict what’s going to happen.”

Even the oil ETF was not immune from further drops.

“Many of those companies don’t have the deep pockets to survive with oil prices at such lows,” he said.

Therefore, this adviser did not rule out the possibility of breaching the 65% barrier.

“If the economists are right, if we recover, this is a good note,” he said.

“But I don’t want to risk 100% of my principal to take a 24% return.

“I may do it with my own portfolio, but not with my clients’ money.”

Barclays is the agent.

The notes (Cusip: 06747PEQ8) settled on Friday.

The fee is 0.55%.

© 2015 Prospect News.
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