JPMorgan, RBC new reverse convertible offer better protection, analyst says; UBS notes seen as risky

By Kenneth Lim

Boston, Jan. 9 - The new reverse convertibles that are being offered by JPMorgan Chase & Co. and Royal Bank of Canada offer better protection for investors, said structured products analyst Suzi Hampson of Future Value Consultants.

Meanwhile, a series of performance securities with upside and downside leverage by UBS AG is one of the riskiest products recently offered, Hampson said.

JPMorgan and RBC recently launched reverse convertibles with buffer features.

JPMorgan's single observation reverse exchangeable notes will return par unless the final underlying stock price is below the protection level, in which case investors will receive a number of shares of the underlying equal to par divided by the initial share price.

RBC offered buffered reverse convertibles that will pay par at maturity unless the underlying finishes below the barrier price. In that case, investors will receive a number of shares of the underlying equal to par divided by the initial share price plus an amount in cash equal to the principal amount times a buffer amount.

Trend toward buffers

The products reflect a trend both in the United States and in the United Kingdom of issuers moving toward buffers in their reverse convertible structures, Hampson said.

"In the last maybe three months or six months, we've seen a change towards more of this buffer," she said. "We are seeing a lot more buffers and kick-outs. It just seems a more transparent way of providing protection."

The RBC structure offers better downside protection than the JPMorgan notes because the minimum payout is the buffer amount, Hampson noted. But both products offer stronger protection than the old reverse convertible structure.

"As far as an investor strategy...it depends on their view, but in six months' time if I think the market might be less volatile, it might calm down, this might be better," she said. "You just have to worry about one date in the future rather than monitor the performance of the stock over six months."

However, investors may have to give up a bit of coupon for the better protection, Hampson said.

"A buffer is worth more to an investor than a barrier at the same level," she said. "You would expect the coupon to be lower on a buffer than a barrier."

UBS offers risky product

Hampson also noted that a series of UBS-issued zero-coupon performance securities with upside and downside leverage due Jan. 14, 2014 linked to the S&P 500 index was one of the most risky products to be offered recently.

At maturity, the UBS notes will pay par plus 210% to 220% of any index gain. If the underlying index is lower at maturity, investors will lose 2% for every 1% decline in the index. The exact upside participation rate will be set at pricing.

The product received Future Value's highest risk score of 10 out of 10, where 10 is the riskiest.

"That's because the downside participation is 200%," Hampson said. "If the index falls, and with no buffer or anything, if the index falls by one you lose two."

But the product also compensates investors with a generous upside leverage, she noted.

"The participation is double on the upside as well, 210% to 220%, so you're getting a good participation on the upside and it's uncapped, so in theory with the uncapped return, if the S&P were to get back to where it was in the summer of 2007, it would be good, but it's a massive risk," Hampson said. "The index only has to fall by 50% for you to lose all your capital."

The product's long tenor suggests that the product suits investors who think the market could experience a recovery before five years, Hampson added.

"I guess that would be the idea of the product," she said. "It's a lot of time for a recovery."

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