Barclays’ callable notes linked to Russell 2000 offer buffer but not much else, source says

By Emma Trincal

New York, July 14 – Barclays Bank plc plans to price 0% callable buffered securities due July 25, 2018 linked to the Russell 2000 index, according to an FWP filing with the Securities and Exchange Commission.

The notes will be callable on July 24, 2017. The early redemption payment is expected to be at least $12 per $10 principal amount of notes and will be set at pricing.

If the notes are not called and the final index level is greater than the initial index level, the payout at maturity will be par plus the index return. Investors will receive par if the index declines by 9% or less and will lose 1% for every 1% that it declines beyond 9%.

At the issuer’s option

Investors can expect to get called if the Russell 2000 is “up nicely,” said Tom Balcom, founder of 1650 Wealth Management.

“You know you’re going to underperform the index for two reasons. First, they’ll call the notes if the market is bullish. It’s at the complete discretion of the issuer,” he said.

The prospectus disclosed what would motivate the issuer to exercise their right to call.

“It is more likely that we will redeem the securities when it would otherwise be advantageous for you to continue to hold the securities. As such, we will be more likely to redeem the securities when the value of the underlier has appreciated significantly,” the prospectus said in its “key investment rationale” section.

“Second, you will underperform because you’re not getting the dividends. The Russell is yielding 1.27%. You’re losing close to 4% in dividend return over the term,” Balcom said.

“The fact that the call is entirely at the discretion of the issuer is not going to help you. It’s not the same as an autocall.

“If the index is up a lot, they’ll call it and you’ll make the call premium minus dividends. Compare that with an autocall that kicks in if the index is flat or up by any amount. If the index is up one basis point, the autocall gets triggered and you make 12% or whatever the call premium is. It’s a much better outcome. The autocall doesn’t necessarily penalize you. ... In fact, it can be the opposite. When it’s a discretionary call like this one, it’s going to work against you, not for you.”

Maturity

The second possible scenario is when the notes remain outstanding until maturity.

“That’s not so great either,” he said.

“It’s only one-to-one, and you’re missing the three years of dividends. You underperform. The only thing I see that’s positive is the 9% buffer. Minus the dividends, it’s more like a 5% buffer. What do I get exactly when I invest in this note?”

Balcom said he would much rather buy a leveraged product even with a cap.

“This note may be uncapped, but it has no leverage, it has a discretionary call that works against me, and I get no dividends,” he said.

“If you want no cap, why not buy the index itself and get out of trouble? You’ll have the liquidity and the dividends, and you don’t run the risk of being called away when the market is up.”

9% buffer

Despite the unpredictability created by the call option, Juin Chin, senior investment analyst at Modera Wealth Management, LLC, said, “I can understand why someone would look into it.”

Chin said that he does not know if the buffer is fairly priced because he has not seen buffered notes on the Russell 2000 index recently, especially with similar terms.

“This note is all about the buffering,” he said.

Near the end of May, Barclays sold a two-and-half-year note linked to the Russell 2000 with a 15% buffer and a 15% digital return, according to data compiled by Prospect News. Buffers have been less common in more recent deals. Most three-year Russell 2000-based products over the past month were capped with an 80% to 75% barrier.

“The Russell 2000 is less volatile than the [MSCI] Emerging Markets index or the [MSCI] EAFE index, but it’s more volatile than the S&P 500. I guess you need to find out if you’re getting paid enough ... for the type of protection you’re receiving,” Chin said.

Outcomes

While investors do not know in advance if their investment will last for two rather than three years, the notes are still an “outcome-oriented” investment, in his view.

“The issuer is the beneficiary of the call option,” he said. But it may work for investors if they’re comfortable with the call premium.

“If the issuer doesn’t call the notes, you still have a chance to participate in the upside without a cap. From an end-user, it’s a pretty defined outcome. On the upside, you know what your potential return may be, and on the downside you get that 9%. You just need to see if this level of protection is competitive compared with other notes.”

Barclays is the agent. Morgan Stanley Wealth Management is a dealer.

The notes will price July 20 and settle July 23.

The Cusip number is 06743Q119.

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