Barclays’ phoenix autocalls on two stocks to offer double-digit return, higher risk profile

By Emma Trincal

New York, Feb. 26 – Barclays Bank plc’s phoenix autocallable notes due Aug. 30, 2022 linked to the least performing of the stocks of Southwest Airlines Co. and Las Vegas Sands Corp., require a certain risk tolerance and familiarity with the underlying stocks on the part of investors, said Tim Mortimer, managing director at Future Value Consultants.

The notes will pay a contingent quarterly coupon at an annual rate of 20% if each stock closes at or above its 70% coupon barrier on a related observation date, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par plus the contingent coupon if each stock closes at or above its initial level on any quarterly call observation date after six months.

The payout at maturity will be par plus any coupon unless any stock finishes below 70% of its initial value, in which case investors will lose 1% for each 1% decline of the worst performing stock.

High-yield

“A 20% coupon is obviously very high, certainly by the standard of most products. But it’s tied to two stocks and that's the main reason,” he said.

Volatility also helped boost the return. Both stocks have a volatility of approximately 42%.

“42% as a knock-in volatility is pretty high,” he said.

“That gives you a lot of value.”

The correlation between the underlying stocks could also contribute to increase the coupon rate. The lower the correlation, the greater the premium available to price a higher yield, he said.

With this note, however, the correlation at 82% offers a mixed picture.

“It’s pretty high, but you can find higher between two stocks and especially between indices,” he said.

Two indexes in a worst-of would have correlations above 95% if in the same geographic area, he said.

“It’s a reasonable product.”

Growth stocks, income play

The barrier was not very defensive, he noted, which also explained the compelling double-digit return.

“70% on the coupon, 70% on the final... that's not very low for two stocks. You can easily see a 30% protection for indices. That’s why you should expect quite a high coupon.

“Because the product shows a very high coupon, it’s a reasonable risk-adjusted return proposition,” he said.

The two stocks – an airline company and a casino stock – are usually bought by investors for growth as they express a bullish view on the post-Covid global economy. But the autocall structure is not designed to chase returns, he said.

“You’re looking for high-yield. All you care about is to see both stocks up and even flat, preferably early,” he said.

A call on the first call date in six months is the preferred outcome, he added.

“People usually want to collect the coupon as long as possible, or at least hold the notes for a full year, so they get the absolute rate of return. But you want to call early so the risk of losing capital is eliminated,” he said.

“You really don't need growth This is not a bet on the economic recovery from Covid-19.

“Now if one of the stocks doubles, the 20% return all of a sudden doesn't look so good, but you can't get everything.”

Stress-testing

Future Value Consultants offers stress-testing on structured notes encompassing simulation tables as well as back-testing analysis.

Using a Monte Carlo simulation, the tests are designed to determine the risk associated with a structured note based on market types and market outcomes.

Five distribution assumption sets are included in each research report for any given product. They represent five market scenarios, which are based on volatility as well as different growth rate assumptions.

The base-case is the neutral assumption, which reflects standard pricing based on the risk-free rate, dividends and volatility of the underlying.

The other four market scenarios are bull, bear, less volatile and more volatile.

Scorecard

Mortimer generated a report for the notes. He focused on one of the most used tests – the scorecard – to analyze the risk parameters of the product.

For this autocallable note, the tests included in the scorecard are probability of barrier breach, probabilities of call at various dates and probabilities of coupon payments at various dates.

Early redemption

“There is a 38% probability of the first call in six months, then as usual the probabilities decline rapidly as you move closer to maturity,” he said.

“The probability of a call at point one is always lower with a worst-of than it is with a single-asset autocall,” he said.

“Still the 38% probability is pretty low. In part it’s because you’re dealing with stocks.”

Typically, the probability of a first call for a worst-of on indices would be around 45%, he added.

The result on the scorecard corresponds to the neutral scenario. In the bull scenario, the probability increases to 42%.

Loss outcome

Investors are especially eager to determine what the odds of losing money are. The barrier breach test offers a probability associated to this negative outcome.

“There is a 32% chance of losing money according to the simulation. That’s quite a lot,” he said.

“At the same time, our simulations are conservative, which means the chances of losses are higher. We don’t put any growth in there.”

He meant that when determining the expected rate of return for the underlying, the model assumes very low growth rates. Growth rates in the bull scenario are much lower than in a real market environment and price declines under the bear assumption are much lower as well.

“If you switch to the bear simulation, the chance of losses is at 38%. Our bear return assumptions are moderate, so the probability of barrier breach is not extremely high. It’s only six percentage points higher than in the neutral case,” he said.

Back-testing

Back-testing over the last 10 years shows a 12% frequency for capital loss, he noted, switching to the back-tested scorecard.

“It's not as bad as the simulation but for a back test it's not great based on what we normally see,” he said.

This may be a good thing because back-testing is often criticized for being too optimistic, he noted.

“In general, a product will back test well but won’t do so well in the simulation.”

In conclusion, Mortimer said that the notes are designed for income and require a certain tolerance for risk.

“Investors who buy these single-stock products really need to be super confident about the underlying. You have to be reasonably sure of the stocks’ prospects,” he said.

“It is a positive story for investors looking for high-yield and who have strong conviction in the stocks they’re betting on.”

Barclays is the agent.

The notes were expected to price on Feb. 25 and to settle on March 2.

The Cusip number is 06748E7L1.

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