Barclays, JPMorgan launch reverse convertibles; structure loses share but still dominates, distributor says

By Kenneth Lim

Boston, Nov. 18 - Reverse convertibles continue to form the bulk of issuances as investors seek better yields in a low-interest rate environment, a structured product distributor said.

Barclays Bank plc and JPMorgan Chase & Co. announced a number of reverse convertibles on Tuesday.

Among them, Barclays is offering 14% reverse convertibles due May 27, 2009 linked to the SPDR Trust, Series 1, with a protection level at 60% of the initial stock price.

Reverse convertibles will return par at maturity unless the stock falls below the protection level during the life of the notes and end below the initial stock price. Otherwise investors will receive the number of shares of the underlying equal to par divided by the initial stock price.

JPMorgan's pipeline has two series of reverse convertibles due Feb. 27, 2009 linked to General Electric Co. and to Target Corp.; two series due May 28, 2009 linked to Apple Inc. and to General Electric; and four series due Nov. 27, 2009 linked to Google Inc., to Microsoft Corp., to AT&T Inc. and to Wal-Mart Stores, Inc.

Structure still dominates

Reverse convertibles have given up some share of structure product volumes in recent months as investors seek less risky offerings, the distributor said.

"Definitely," the distributor said. "There's been a bit of a shift away from non-principal protected products, and reverse convertibles also tend to be bullish strategies, so when there's a lot of uncertainty about the equity markets, this particular strategy also loses some of its attractiveness."

But the structure continues to dominate the market, the distributor said.

"You can call it a quirk of the U.S. market," the distributor said. "Reverse convertibles have become, for better or for worse, the mainstay of structured products in the U.S. I think you'll continue to see a lot of them just because investors and broker-dealers and RIAs [registered investment advisers] are familiar with them and they understand them."

Attractive yields

Reverse convertibles also benefit from the current low interest rate environment and the highly volatile markets, the distributor said.

"Interest rates are really low right now, and reverse convertibles can offer very attractive yields that far exceed what investors would get in risk-free instruments," the distributor said. "It's hard to beat inflation with a plain vanilla CD, so reverse convertibles and other structured products offer alternatives for investors.

"The income that you get on reverse convertibles are also much higher now because volatility in the underlying stocks have gone up by a lot, and issuers can offer much higher coupons or lower barriers. You can't offer the same kind of yield on principal-protected products because it's just too expensive for the issuers."

The distributor noted that reverse convertibles are nevertheless risky investments.

"Some of these headline numbers can be very seductive," the distributor said. "Our job is to make sure that our clients understand how the structure works, that they understand the risks as well as the potential rewards so that the investors can make the best informed decision about the products. This is especially true given the current market environment, where people are very conscious about risks, and we pride ourselves in helping people to understand those risks."

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