Barclays' double short leverage notes tied to 30Y Treasury seen as attractive but risky deal

By Emma Trincal

New York, May 2 - An upcoming note from Barclays Bank plc will give investors a way to capture leveraged gains on rising interest rates, a bet that some said is timely.

But sources also noted that the structure is risky due to the inherent dangers of shorting with leverage in any asset class, the difficulty of timing a Treasury sell-off and a call feature that could force an early redemption at a stiff loss.

Barclays plans to price 0% double short leverage securities due May 30, 2014 linked to the Barclays Capital 30Y Treasury Futures index, according to an FWP filing with the Securities and Exchange Commission.

The notes will price at 103.6.

The notes will be putable at any time, subject to a minimum of 1,000 securities, and they will be called if the index increases by more than 35%.

The payout at maturity or upon redemption will be par minus 200% of the index return plus an additional amount and minus an investor fee. The notes are not principal protected.

The additional amount is equal to the interest accrued on the principal amount at a rate per year equal to overnight Libor, compounded daily.

The investor fee will be zero if the final valuation date occurs in the first year, 0.85% if it occurs in the second year and 1.7% if it occurs in the third year.

Costly short

"Whenever you take a short position, there is risk. As the short seller on the bond, you have to pay the coupon. On a 30-year Treasury, that's a lot to pay each year," said Thomas Balcom, financial adviser at Ibis Wealth Management.

As long as the index performance enables investors to make up for those interest payments, the trade would make sense, said Balcom. But the returns need to be high enough.

"It's a great tool if you believe in a sharp and quick rise in interest rates. But if the rise is only moderate and progressive, how useful will it be?" he said.

"You really have to have a conviction that rates will soar quickly. There's nothing wrong with the product, but you have to make sure that you're buying a note that matches your view."

Plus

Michael Kalscheur, financial adviser at Castle Wealth Advisors, said that he liked several aspects of the product. But overall, he would not buy it because of some significant risk factors that are part of the structure.

"Barclays' credit is the best of the best. Issuer's risk isn't an issue at all for us here," he said.

"I also completely agree with the premise that interest rates will be higher in three years."

He saw the point-to-point payout structure of the notes as an advantage as well, especially when compared to an exchange-traded fund.

"With an ETF, you could be 1% down and 1% up; it doesn't get you back to even. Here you don't have to deal with the back-and-forth," he said.

Minus

But cost and, above all, risk factors were an issue for Kalscheur.

"The 30-year [Treasury] is more volatile than the 20-year," he said, adding that he owns an ETF that gives inverse leveraged exposure to the 20-year Treasury index, the ProShares UltraShort 20+ Year Treasury ETF.

Kalscheur also noted that the notes will be sold at a premium.

"You have this $36 to pay right off the bat. It's similar in a way to the upfront load you would pay in a mutual fund."

Deal breaker

Kalscheur's main objection to the deal, however, was the early redemption feature, which enables the issuer to call the notes if the index increases by more than 35%.

"I have a big hang-up on the risk. If it breaks the 35% threshold, it will be called and you'll be kicked out at the bottom without having the time to rebound," he said.

He noted that the call could be triggered at much higher levels than 35%.

"Some call it a contingent buffer. But what it does is make you sell at the bottom. It's a buffer but not really a buffer. It's protection after the damage, when it's too late. I'm not a big fan of these things," he said.

Kalscheur looked back in recent history at periods of extreme market disruption, for instance the financial crisis of 2008 when Treasuries rallied in a flight to quality. In his view, those rallies are hard to predict.

He looked at an example in the prospectus describing the following scenario: The initial index is 182. In the second year, the index closes at 246 and the notes are called. Investors lose just about 60% of their principal. Because the loss is automatically generated by the call, Kalscheur said that the notes were not "defensive" enough.

"Our clients tend to be risk averse. If you have another 2008, you'll be wiped out," he said.

"Force selling at the worse possible time is not a very defensive strategy.

"Do I envision something worse than 2008 in three years? No. I don't anticipate Armageddon. Could we have something that bad? Certainly.

"We would have to take a pass at this particular issue even though we like the issuer, we like the view. We just don't like the structure."

The notes (Cusip: 06738KJD4) will price May 25 and settle May 31.

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

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.