Barclays' leveraged short notes on 30-year Treasuries seen as timely but high risk and cost

By Emma Trincal

New York, Nov. 3 - Barclays Bank plc's plans to price two offerings of one-year 0% notes designed to double-short the performance of the 30-year Treasury are a timely macroeconomic bet, sources said, but the short duration, the two-to-one leverage and the cost of the deals limit their appeal.

Barclays plans to price via UBS two offerings of one-year 0% double short leverage securities inversely linked to the Barclays Capital 30-year Treasury Futures index, according to an FWP filing with the Securities and Exchange Commission.

Increased risk and return

The payout at maturity will be par minus 200% of the index return plus the interest expense. The notes are not principal protected, so the payout will be reduced by any positive performance on the index on a two-times leveraged basis.

Popular macro theme

"I think this trade makes sense right now. This is similar to owning the ProShares UltraShort Treasury ETF [exchange-traded fund], which we own," said Greg Feirman, president and chief executive of Top Gun Financial Planning in Granite Bay, Calif.

"I'm short long-term Treasuries for all the same reasons Julian Robertson is short long-term Treasuries. We have a huge budget deficit and the Fed [Federal Reserve Board] is printing all those dollars. This will further weaken our currency. We depend on other countries like China to pay for our account deficit. Right now they own large reserves of Treasuries yielding almost nothing. If they stop buying Treasuries or cut back, we may have a significant sell off, which is why a lot of people are now shorting government bonds," Feirman said.

Julian Robertson, a famous hedge fund manager and founder of Tiger Management, has recently made it public that he was shorting Treasuries in anticipation of higher interest rates induced by the increasing amount of government borrowing.

Limited downside protection

The investment in the short leveraged notes involves risks as outlined by the prospectus. Investors are subject to a double leveraged downside exposure, according to the document. However, the 12-month term is subject to the occurrence of an early redemption event.

The notes will be called if the index increases by more than 35%, in which case, the redemption amount will be calculated in the same way as the payout at maturity, which would trigger a 70% loss of principal.

But such a sharp rise in one year would be exceptional based on the historical performance of the index. A table in the prospectus shows that it took five years since January 1997 for the index to gain 35%.

Too short to short

While shorting long-term Treasuries "makes sense from a macroeconomic standpoint," Feirman said that he was not comfortable with the short maturity of the offering.

"This is a big macro call and it's going to happen and we'll have a Treasury sell off. But I wouldn't want to be saying it's going to happen in a year," he said. "I think a year term is a little bit too short"

Double leverage

A hedge fund manager who trades U.S. Treasury options said that "it's a right time to employ a strategy like that" also invoking the likelihood of s Treasury sell off.

He said that the strategy is a good fit for those who are bearish on the long-term Treasury market as it gives them a chance to earn twice any negative return of the index.

But he stressed the risk involved with the double leverage exposure as for every 1% increase in the index return investors will lose 2% of their principal at maturity.

This trader said that he would not short long-term Treasuries on a one-year term without a hedge.

"I am more of a spread trader and if I had to be short the 30-year Treasury, I would be long the 10-year at the same time," he said.

Costly bet

This hedge fund trader said that, "I guess it's a way for the retail guy to play the game. Most people can't short Treasuries because they don't have enough money. And using Treasury puts is not something that a retail investor can understand easily. My problem with these notes though is that it's very fee-heavy."

The notes will price at 102.6 for a face value of 100, with the difference representing the agents' commissions and the issuer's estimated cost of hedging, according to the prospectus.

Zero coupon

The notes do not pay interest during the term.

The interest expense will be an amount equal to the interest accrued on the principal amount at a rate per year equal to overnight Libor, compounded on each business day during the accrual period, according to the prospectus.

The index reflects the return available by maintaining a rolling position in 30-year U.S. Treasury futures contracts. The index comprises a single 30-year Treasury futures contract at a time that is either the contract closest to expiration or the next 30-year Treasury futures contract scheduled to expire immediately following the front 30-year Treasury futures contract.

An issue of notes due Dec. 1, 2010 will price Nov. 24 and settle Nov. 30.

An issue of notes due Dec. 28, 2010 will price Dec. 21 and settle Dec. 24.

UBS Financial Services Inc. and Barclays Capital Inc. are the underwriters.

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