Barclays’ range accrual notes tied to S&P look good, but call is ‘deal breaker,’ sources say

By Emma Trincal

New York, Nov. 7 – Barclays Bank plc’s callable range accrual notes due May 31, 2024 linked to the performance of the S&P 500 index would offer a very attractive structure if only the discretionary call feature were not part of the deal, financial advisers said.

Interest will accrue at 6.1% per year multiplied by the proportion of days on which the index closes at or above the coupon barrier level, which is 80% of the initial level. Interest is payable monthly, according to a 424B2 filing with the Securities and Exchange Commission.

If the final index level is greater than or equal to the 80% buffer level, the payout at maturity will be par. Otherwise, investors will lose 1% for every 1% decline beyond 20%.

After November 2017, the notes will be callable at par on any interest payment date.

Imagine no call

“Imagine this note without the call,” said Carl Kunhardt, wealth adviser at Quest Capital Management.

“It’s a pretty attractive note because of the term. The length of the contract actually works out because the further you get from the original pricing, the less likely it is to breach that 80% level.”

Not receiving enough or any coupon payment for a long time is the main risk involved with the notes, he said.

“The only way you get hurt is by not collecting your coupon. If the market is down at the beginning, you may spend half or a third of the term of the notes just getting back to even.”

Equity substitute

Kunhardt said that he would use the notes as an equity substitute.

“I’m not sure I would play it as fixed income. I like a little bit more certainty on the income stream. But I could use it as a risk-mitigation tool just like a dividend stock has less volatility so you can get a smoother ride on the value side.

“I can see using it just like a dividend stock.”

Unfortunately, the call feature makes a difference. The issuer’s sole discretion to call the notes after one year is more than an inconvenient feature for Kunhardt.

“The call sort of ruins it. What made the notes so attractive was the long tenor with the possibility of collecting the coupon for a while,” he said.

“If you have a really bad market up front, you may not have the opportunity to make that up, or if you’re making up the return, you may get called.

“It’s a different note altogether.”

Credit, terms

Michael Kalscheur, financial adviser at Castle Wealth Advisors, holds a similar view.

“That kind of sealed the deal for me. If you had this not callable, it would have been a very good product. But I can’t get excited about it because of the call,” he said.

Kalscheur said he is “comfortable” with Barclays’ credit as well as with the stated maturity.

“The term is nice and long. We like long-term. Seven and a half is even long for us but not a problem,” he said.

However, over a long maturity the non-payment of dividends raises the opportunity cost. When a coupon caps the upside, the actual return net of dividends may not be as attractive as it seems, he noted.

“The S&P is already yielding 2%, so it’s really 4.1% that you may get. You have to look at your net coupon. That’s not a deal-killer, but it’s something to keep in mind,” he said.

Kalscheur said the 20% buffer is “very good.”

Using statistics his firm has compiled on the S&P 500 performance since 1950, he said that the odds of losing more than 20% on any seven-year rolling period during the past 66 years were less than 2%.

Call risk

“The deal breaker for me is the call. If the market moves range bound but stays above the 80% barrier, they have to pay you. That means you could get called by the issuer.”

The odds of getting called are even greater if the market is up, he reasoned.

“Statistically, the market shows a positive performance over a 12-month period 73% of the time, so the probabilities of being called just after one year are pretty high,” he said.

The issuer charges a 4% fee. When broken down over the seven-and-a-half-year term, the 4% fee becomes “very competitive,” he said, at about 50 basis points a year.

“Imagine having to pay a 4% fee for one year? It’s ridiculous. You’ve got hedge funds that don’t charge that.”

Uncertainty

Kalscheur said he is uncomfortable with the unpredictability of the notes’ payout.

“Not knowing how long I am going to be in is a problem for us. It can be 12 months. It can be 90 months. It’s a pretty big swing,” he said.

“They may take you out when it benefits them.

“If my time horizon is 20 years, fine. But most people in income are going to be retirees. For them, seven and a half years is a long time.

“If you’re going to take the illiquidity risk of that time commitment, you’d better know what you’re getting for that.

“The amount of income you’ll receive is uncertain. The length of your investment is uncertain. The amount of principal you get at the end is uncertain even if the 20% buffer is good.

“The mere possibility that you’re going to get called out as early as a year from now defeats the purpose of a note like this.

“I can buy a high-yield bond and get 6%. At least I can control my liquidity. I’m not at the mercy of the market and the issuer.

“I just can’t get excited about this one. I’ll pass.”

Barclays is the agent.

The notes (Cusip: 06741VEA6) will price on Nov. 28 and settle on Nov. 30.

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