Barclays’ 9%-11% airbag autocallables linked to Netflix score at high end of risk spectrum

By Emma Trincal

New York, Oct. 23 – Barclays Bank plc’s 9% to 11% airbag autocallable yield optimization notes due Oct. 28, 2016 linked to the common stock of Netflix, Inc. are designed for investors seeking income, but the risk involved to capture the yield is sizable, said Tim Vile, structured product analyst at Future Value Consultants.

The notes will be called automatically at par if Netflix shares close at or above the initial share price on any quarterly observation date, according to an FWP filing with the Securities and Exchange Commission.

Interest will be payable monthly.

The payout at maturity will be par unless the final share price is less than the conversion price, in which case the payout will be a number of Netflix shares equal to $1,000 divided by the conversion price. The conversion price will be 65% of the initial share price.

For his research report, Vile based his analysis on a 10% coupon, which is the mid-point of the range. The exact interest rate will be set at pricing.

“The note pays a fixed income of 10%. That’s about 0.83% a month. Assuming the note kicks out on the first call date, it gives you a 2.5% return in just three months,” he said.

Point-to-point

“At maturity, you benefit from the European type of barrier. Only the final level counts. The stock can drop more than 35% anytime ... as long as it doesn’t breach that 35% threshold at maturity, you’re safe,” he said.

This type of barrier is advantageous compared to the more commonly used American barrier, one that is monitored during the life of the securities, he said.

The fixed coupon also provides some protection.

“Your principal is at risk, but you have the 10% guaranteed, which offers a little cushion,” he said.

Despite those defensive features, investors incur significant market risk, he noted.

“Netflix is a very volatile stock. Its implied volatility is around the 50% mark,” he said.

The 52-week range of the stock is $45 to $130.

Since its peak in August, the share price has dropped 23%.

The stock was trading over $100 in Friday’s late afternoon trading session.

“We’re talking about a momentum stock that can move quite a lot even in one day, particularly on earnings,” he said.

“So even though you have a 65% final barrier, it can be easily breached with a stock like this. The volatility of the underlying makes the trade quite risky,” he said.

First autocall date

The autocallable provision, however, helps mitigate risk.

“If it kicks out early, the investor gets his coupon plus 100% of his principal back. The risk is off the table. No more concern of breaching the barrier at maturity at this point,” he said.

He added that the automatic early redemption is more likely to occur on the first call date as is the case with autocallable products in general.

“The kick out is less likely to happen with time. If you don’t get called on the first call date, it means the stock is down after three months. It just requires a higher move on the upside to get to the required initial price on the following observation.”

Whether investors benefit from an autocall occurring on the first call date is a function of the pursued strategy.

“It’s not the best outcome in the sense that you have not collected the full coupon. You also have to reinvest your money, and you have paid the fee for the year,” he said.

“But getting all your money back with a 2.5% return in just three months is certainly not a bad outcome. A lot of people would be very happy with that.”

Investors in the product are income-seekers by definition.

“Those people are looking for yield. They don’t have a strong bullish outlook, otherwise they would go for participation rather than fixed income.

“The 35% contingent protection and the European barrier will help you out, but the potentially big and sudden price moves seen with Netflix create a lot of risk. Unless you price the note, it’s hard to tell if 10% is enough to compensate investors for the risk induced by this extremely volatile underlier.”

In its research, Future Value Consultants assesses risk, return and price using a variety of proprietary scores in order to compare a product to others.

In this report, the firm compared the notes to all product types recently rated.

Risk

Future Value Consultants assesses the risk associated with a product by adding two risk components – market risk and credit risk. The resulting riskmap measures risk on a scale of zero to 10 with 10 as the highest level of risk possible.

The notes have a 5.83 market riskmap versus an average of 3.42 for all product types, according to the research report.

Vile reiterated the cause behind the high market risk: the share price can move significantly and rapidly.

The credit risk offered a better picture with a 0.27 credit riskmap, lower than the 0.49 average for all products.

“The credit risk is quite low because of the one-year maturity of the product. Also the kick-out can shorten the term. Finally, Barclays is a strong issuer,” he said.

But the market risk factor weighed in.

The sum of the two risk components – market riskmap and credit riskmap –gives a 6.10 riskmap, compared with the market’s average of 3.91.

Risk-adjusted return

Future Value Consultants measures the risk-adjusted return on a scale of zero to 10, with 10 the optimal level, via its return score. The score is calculated using the best market scenario among five hypothetical ones.

At 4.95, the return score is lower than the 8.30 average for all products.

“It’s not very good at all ... mainly because the risk is too high. The score suggests that for this amount of risk, the coupon may not be sufficient. The coupon itself is a factor as it caps the return. There is no participation in the upside,” he said.

Price score

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10. This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

The notes have a 4.17 price score while the general average is 6.22, according to the report.

“There’s not enough upside given the volatility and risk. The score suggests that investors are not getting enough value from this product,” he said.

Overall score

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. The score is the average of the price score and the return score.

The overall score is 4.56, compared with the 7.26 average for all products.

“It’s not that great. ... Not the strongest product. But for investors chasing yield and ready to take that kind of risk, 10% is attractive. There are a lot of riskier products out there. This one though is on the high end of the spectrum,” he said.

UBS Financial Services Inc. and Barclays are the agents.

The notes were expected to price Friday and will settle Wednesday.

The Cusip number is 06743Q218.

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