Barclays' quarterly review notes tied to copper may offer high call premium, but risk looms

By Emma Trincal

New York, Jan. 21 - Barclays Bank plc's sale of $12.01 million quarterly review notes linked to copper via JPMorgan may have attracted investors looking to get commodity exposure, high income and partial downside protection, sources said. But the notes still require a robust tolerance for risk given the volatility of the underlying asset, which makes it unsuitable for the most conservative investors, others said.

The 0% notes are due Jan. 21, 2011, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be automatically called if the average price of copper for any of four quarterly review dates is greater than or equal to the initial price of copper. The redemption amount will be par plus an annualized call premium of 20.1%.

The review dates are April 15, 2010, July 15, 2010, Oct. 15, 2010 and Jan. 18, 2011.

The average price of copper for any review date will be the average of the settlement prices of copper for the five trading days ending on that review date.

If the notes are not called, the payout at maturity will be par as long as the final price of copper is at least 85% of the initial copper price. Otherwise, investors will be fully exposed to the decline.

The underlying asset is the official price of copper per ton based on the Bloomberg ticker symbol "LOCADY ."

The initial price is $7,405.50, which was last Friday's settlement price. According to a chart exhibited in the prospectus, copper was trading at approximately $3,000 a year ago. The commodity's price rose by almost 150% in just one year.

Early exit

According to the prospectus, the notes are designed for investors who seek an early exit prior to maturity at a premium if the average settlement price of copper is at or above the initial price on any of the four quarterly review dates.

For instance, if the notes get called in April, investors will earn a 5.025% coupon in just three months. The return would be 10.05% in July and 15.075% in October.

If the notes are not called, investors are protected at maturity against up to a 15% decline of the price of copper but will lose some of their principal if the decline exceeds 15%.

For instance, a 20% drop in the price of copper on any review date would cause investors to lose 20% of their principal.

Fair enough

"For the risk adverse, the downside is the lack of full principal protection and the possibility to lose 100% of their initial investment," said Marc Gerstein, a research consultant with Portfolio 123. "For very bullish investors - those who see copper going up from $8,000 to $12,000, the drawback is the 20% cap on the upside; those people wouldn't be interested in the notes."

Gerstein said that investors "who like copper" and "who don't see it rising that much" would be "happy" with a 20% return.

"You have a 20% cap on the upside and a possible 100% loss. But you get a free pass for the first 15% decline.

"While I don't have an opinion on copper, I don't dislike this product. There's a place for it. It gives investors a chance to speculate on commodities with some downside protection, instead of the typical futures play, which would expose you to a 100% loss without any cushion," noted Gerstein.

Gerstein added, "This is not a completely one-sided deal. It's the kind of structure that fits my idea of what a structured product should be, of what makes a structured product interesting. I wouldn't dismiss it."

He noted that an investor buying copper via futures might enjoy the uncapped return but, on the other hand, would not benefit from the 15% partial downside protection.

"A structured product should work that way. It gives you the opportunity to speculate, but you do that by redrawing the risk to fit your risk-reward profile," Gerstein said.

Pointing to the sharp rise of copper prices in the past year, Gerstein said, "A year ago, I might have thought that the 20% capped return was a little bit depressed. But now it makes more sense."

However, the notes involve risk as well, Gerstein said.

"This is not for the risk-adverse investor. You can lose 100% of your principal. It's not for everybody," said Gerstein. "But there is a market for this. A financial adviser would really have to know his clients and be familiar with their risk tolerance level. Some might like it. And some might hate it."

Frederic Wright, partner and chief investment officer at Smith & Howard Wealth Management in Atlanta, said that he is one of those financial advisers who pay attention to the downside risk. He said he would not offer the notes to his clients given the odds of "losing a lot."

Copper roller coaster

"This is an interesting deal. But you can still lose a lot of money. I'd rather see some downside protection. Show me a structure where I can only lose 15% no matter where [the] copper price goes," Wright said.

"I'm more interested in the downside protection. The 15% [barrier] doesn't give you that much downside protection. It sounds nice if you're coming from a low price. But copper has been appreciating so much in such a short time, you could easily lose more than 40% of your investment and copper would be still at the same price as last year," he said.

Wright offered the following example: He assumed that copper over the course of the next 12 months would drop back to the price at which it traded a year ago, or approximately $3,000. This would represent a 59% loss of principal for the noteholder, although the price of copper would have remained the same between a year ago and a year from now.

Cost of uncertainty

Wright said that some investors may find a place for this investment in their portfolios, but those may not represent the majority of the investors in structured products.

"It's attractive for someone who is used to investing in commodity directly and who can sustain the risk. Most people don't. You can be a relatively unsophisticated investor and find the 20% return appealing. But you have to look at the downside. The chances are real that you may lose a lot simply because copper is already so rich," he said.

"For the normal registered adviser who is looking at protecting his clients' assets and moving risk off the table, this is not so great. I don't like it. I don't want to be in a situation where my client could lose such a big chunk of their principal."

JPMorgan Chase Bank, NA and J.P. Morgan Securities Inc. are the agents.

The notes settled on Thursday.

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