Barclays’ 6.4%-8.4% airbag autocallables tied to General Motors show higher-than-average risk

By Emma Trincal

New York, Oct. 14 – Barclays Bank plc’s 6.4% to 8.4% airbag autocallable yield notes due Oct. 25, 2017 linked to General Motors Co. shares showed disappointing pricing and risk-adjusted return scores, according to Future Value Consultants’ methodology.

The scores reflect the challenges issuers are facing when putting together reverse convertibles with fixed coupons while attempting to limit risk, said Tim Vile, structured products analyst at Future Value Consultants.

“This is not a bad note, but it’s tied to one single asset, it has a fixed rate, it’s very short. You’re not going to get a huge coupon, and in this case the barrier is not very deep,” Vile said.

Interest will be payable monthly, with the exact rate to be set at pricing, according to an FWP with the Securities and Exchange Commission.

The notes will be called at par if General Motors shares close at or above the initial share price on any quarterly observation date.

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 General Motors shares equal to $1,000 divided by the conversion price. The conversion price will be 88% of the initial share price.

Tough to price

Reverse convertibles with a fixed coupon, such as this product, have become less common in the market because they are harder to price, he said.

“As a rule, this category of product doesn’t score well in our system.”

He explained why: “First, they are short. The autocall reduces the duration as well. The short term is not going to give you the most value since the fees are calculated per annum.

“Second, getting a fixed coupon is expensive. You’re not likely to get a very high coupon unless you use either a worst-of with several underlying or a very volatile stock.

“One way or the other, you have to take some substantial amount of risk to guarantee the coupon.”

Issuers as a result have multiplied contingent coupon autocallable structures that offer a higher premium. The use of worst-of structures has also increased.

“Issuers are increasingly using contingency and worst-of. That’s sort of the way reverse convertibles are now being done,” he said.

Future Value Consultants compares each product with the average on the basis of risk, risk-adjusted return and value using its own proprietary scores.

Fairly risky

The research firm measures the risk, or “riskmap”, by adding two risk components, the market riskmap and the credit riskmap. Each score is established on a scale of zero to 10 with 10 representing the maximum amount of risk.

The market riskmap for the notes is 4.05 while the average for all products is 1.53, according to Future Value Consultants’ research report.

“This is generally true for this product type. Here, we have a reasonably volatile stock. Its implied volatility is around 25% or 26% versus 18% to 19% for the S&P,” he said.

“For that amount of risk you are only getting a contingent protection of 12%. It’s a bit weak on that end.

“At the same time, you’re always going to have a less protective barrier on a shorter product.

“The autocall normally reduces the risk because it gives you an opportunity to get out early with your final coupon and no loss of principal.

“But in this case, the volatility of the underlying combined with the modest barrier contributes to elevate the risk.”

Inversely, the credit risk was relatively muted, according to the report, which showed a credit riskmap of 0.29, less than the 0.50 average for all products.

Vile attributed the result to the short tenor.

“It’s a one-year. Barclays is unlikely to go out of business in one year. Plus we take into account the autocall when we calculate the duration of the notes, so it’s actually shorter than one year,” he said.

The issuer’s creditworthiness played little part in the credit riskmap.

Barclays showed credit default swap spreads of 109 basis points on Friday, according to Markit. It was wider than its British counterpart, HSBC, which showed spreads of 83 bps. The largest U.S. banks also had tighter spreads, ranging from 61 bps for Wells Fargo to 96 bps for Goldman Sachs.

The resulting riskmap after adding the market and credit risk components was 4.33 versus an average of 2.04 for all products.

The share price of General Motors has been “going up and down” over the past year. It lost 26% between November 2015 and February 2016 and then went back up more than 20% in the next two months, he noted.

“The 88% barrier can be easily breached,” he said.

Risk-adjusted return

The return score measures the risk-adjusted return of a note on a scale of zero to 10 with 10 indicating the optimal result.

The return score is 5.81, compared to an average of 7.16 for all products.

“Anytime you have a product with a fair amount of risk and limited upside, you’re not going to get an attractive return score unless your cap or coupon is really high,” he said.

“This product is an example of this. You have a high riskmap and a 7.4% coupon. Even if the stock doubles, you’re not going to get more than that. When compared with some uncapped leveraged notes, you are going to be left behind.”

Vile used the midpoint of the cap range, or 7.4%, to generate his report. If the issuer priced the coupon one point above 7.4%, the price score would naturally improve.

Still, most reverse convertibles have low return scores, he said.

“By definition having a cap on your return while risking much or all of your investment based on the performance of a single stock is not a good risk-adjusted return.”

Value

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. By the same token, short-term products will not score as well on the price scale because there is not as much time to amortize the cost induced by the fees.

At 5.32, the price score of this product is much lower than the 8.36 average score, he noted.

“The short tenor and the autocall punish the price score, but it’s also because more could have been spent on the options. While this is a European, not an American, barrier, the 12% level of protection is quite thin. You can easily break through the barrier,” he said.

The terms “European” and “American” refer to how and when a barrier will be observed. A European barrier is observed only at maturity while an American barrier can be observed periodically during the life of the notes, usually on any day.

Overall

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 notes have a 5.57 overall score, which is below the average of 7.76.

“This reflects in part the general risk profile of this type of structure. While the notes are designed for investors who want a guaranteed coupon, they are not fixed-income instruments. Your capital is not protected, and in this case you’re taking a certain degree of risk. The main issue with these notes and with this product in particular is the insufficient safety on the downside,” he said.

UBS Financial Services Inc. and Barclays are the agents.

The notes will settle on Wednesday.

The Cusip number is 06744M877.

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