Barclays' $70.28 million 7% STEP Income notes linked to GE offer income in a flat market

By Emma Trincal

New York, July 20 - Barclays Bank plc's $70.28 million of 7% STEP Income Securities due July 27, 2012 linked to the performance of General Electric Co. shares are for investors seeking income who believe the stock will grow slowly, sources said.

Interest will be payable quarterly, according to a 424B2 filing with the Securities and Exchange Commission.

If the price of General Electric shares finishes at or above the step level - 107% of the initial price - the payout at maturity will be par of $10 plus 7.11%.

If the stock finishes at or above the initial price but below the step level, the payout will be par.

Investors will be fully exposed to the decline if the stock finishes below the initial price.

Bank of America Merrill Lynch is the agent.

Moderate growth

"It's a strategy to earn income in a flat or moderately bullish market," said Brad Livingston, vice president at the Income Solutions Group with Capital Guardian LLC.

The maximum return investors may expect to generate is 14% a year, Livingston said. This would occur if the stock ended above the step level, enabling investors to cumulate the 7% coupon and the 7.11% step payment.

"The step income is obtained by selling a call," he said.

Livingston said that the strategy is suitable for investors who do not see the market rallying much over the coming months. The fact that many investors feel that way may explain the popularity of this deal, he said. The offering topped the list of biggest deals last week.

"With current market conditions, I haven't seen many people projecting a positive 2012," he said.

"As long as General Electric can stay on the surface, flat, these types of deals will remain popular."

Investors in the notes should not be bearish, however.

"You're shorting a put at the initial strike price; you receive a 7% put premium and after that, you participate one for one in the downside," he said.

"But you're hopeful that the stock goes over the coupon."

Tight window

"It's only if General Electric ends up between 0% and 14% that you will outperform the stock," Livingston said.

For instance, if the stock is up 4%, investors will earn the 7% coupon payment. If its performance is 8%, the return on the note will be boosted to 14%, he explained. Beyond the 14% cap, the best option would be to own the stock, he said.

"Getting a return of zero to 14% on the stock, that's a pretty tight window," he said. "You'd have to have a flat to slightly positive outlook."

Livingston said he was unsure whether he would be interested in this structure because "the ability to outperform the stock is limited."

"I use structured products for two reasons: either to improve my return with less risk than the underlying security or to reduce my risk," he said.

Other structures, such as knock-outs, he said, do a better job at enhancing returns.

Income play

Paul Weisbruch, vice president of options sales and trading at Street One Financial, said that the notes could be used by income seekers or value investors.

"This product is for an investor looking for a status quo," he said. "If the stock stays where it is or higher, you're a winner.

"It's a way to supplement your return in addition to owning the stock. The stock isn't paying a high dividend, or at least not as much as what the coupon is paying here."

Value investors

Weisbruch, however, said that investors in the notes should be aware of the downside risk and willing to embrace it. Their only protection is the amount of fixed coupon they get, which in a bearish scenario could be used as a cushion.

"You have to be pretty confident in the name and be able to stomach the loss," he said.

"The profile would be a deep value guy, a fundamental player who keeps adding to his position versus the technical or momentum trader."

No visible trend

The outlook for the stock is not clear, he said, from the perspective of trading equity options.

"It's hard to discern if there is a bullish or bearish interest. There is heavy trading on options for GE on a day-to-day basis, millions of contracts that trade each day. If it was a less popular name it would be easier to discern a trend," he said.

"From a technical standpoint, the stock has rallied back to its 200-day moving average. Technicians are probably watching these levels to see if it stays there. If it does, it would be a bullish signal and I would expect an increased demand for calls."

There have been seven structured products linked to General Electric prior to this one so far this year. This offering is the second largest in size after a $150 million issue of buy-write notes priced by Citigroup Inc. in January.

Fees are 1.75%.

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