Bank of Montreal prices its fourth deal with a 15.52% reverse convertible tied to Fifth Third

By Emma Trincal

New York, Oct. 19 - Bank of Montreal priced $830,000 of 15.52% annualized reverse exchangeable notes due Jan. 18, 2011 linked to the common stock of Fifth Third Bancorp in a "reasonably priced" deal linked to a less-common bank name, sources said.

Yet since the launch of its U.S. note business earlier this year, Bank of Montreal's U.S. brokerage arm, BMO Capital Markets Corp., has not been very active, a market participant noted.

"They're in for a tough time," the market participant said. "It's not easy to establish your own distribution."

This is only the fourth deal issued this year by Bank of Montreal, with BMO acting as the agent, data compiled by Prospect News shows.

Fourth deal

The first one - and the biggest one - hit the market in April: a $50 million issue of 10-year redeemable range accrual notes linked to Libor.

The second offering, also in April, was a $350,000 offering of zero-coupon principal-protected commodity-linked notes due Oct. 30, 2015 linked to six subindexes of the Dow Jones - UBS Commodity index.

Finally last month, Bank of Montreal priced $750,000 of three-month reverse convertible notes tied to KeyCorp, another bank stock.

The expansion of the structured notes business into the United States began in March with the hiring of Laurence Kaplan from Royal Bank of Canada. Kaplan joined BMO as managing director and head of the U.S. and Latam retail investors solutions group in New York.

As previously reported, BMO has only began to build up its note franchise recently, hiring key staffers this summer. But its presence in the certificates of deposit market has been recognized for a couple of years through Harris Bank.

New kid

Still, sources said that the establishment of a note platform that can compete with other New York-based firms will take time.

"BMO is a newcomer in the structured notes market in the U.S.," the market participant said.

"When you're a foreign bank, it's even harder. Even RBC hasn't had a great success in distribution in the U.S. either."

RBC is ranked No. 8 in the league tables for the year to date. It has sold $708 million in 688 deals, which represents 1.47% of the total volume, according to data compiled by Prospect News.

BMO holds the 15th slot with $52 million sold through its four deals, or 0.11% of the market.

Tough competition

"With structured notes, it's important to have products that are shown around. There are so many offerings out there, you really have to differentiate yourself," the market participant said.

"The market is already floated with reverse convertibles. You have a Barclays that can issue 30, 40 of those a month, and RBC too. It's overwhelming.

"And the underlying stock itself, Fifth Third, is not a well-known name like JPMorgan. The big boys can get away with this. They can come out with a research report and generate significant-size deals. But BMO's research is not that well known."

Peter Winter, analyst at BMO Capital Markets, covers Fifth Third and has a buy rating on it.

Sources also recognized that BMO's launch of its new U.S. structured note franchise is too recent to be judged by the size or number of its deals.

Fifth Third

The deal on Fifth Third, which priced Oct. 12, was competitive with other offerings, they noted.

The notes had a 75% barrier and carried a 1.5% fee.

The underlying stock is up 24.5% year to date.

The stock's historical volatility, at 62.96%, is much greater than that of the S&P 500 index, which is approximately 24%, said Suzi Hampson, structured products analyst at Future Value Consultants.

There have been 15 deals linked to the shares of Fifth Third this year, according to data compiled by Prospect News, most of which with a three-month tenor.

Even though the underlying is not as widely used as other bank stocks - such as Bank of America Corp., which has been used in 73 deals this year, or JPMorgan Chase & Co., employed in 30 deals - other firms have also used Fifth Third as a reference asset, according to data compiled by Prospect News.

Royal Bank of Canada and Barclays Bank plc have priced eight and six deals, respectively, based on the stock so far this year.

Competitive structure

RBC was slated to price a reverse convertible offering linked to Fifth Third on Friday with a 12.75% annualized coupon and a barrier of 80%, according to an FWP filing with the Securities and Exchange Commission.

"I think the BMO deal is pretty standard. The 75% barrier is good for a three-month, but it's not uncommon," said Hampson. "The 15% is quite good as well.

"But what sets them apart is the credit quality. Bank of Montreal has an issuer credit rating of A+ from Standard & Poor's. Its credit default swaps spreads, at 50 basis points, are at much tighter levels than most of its U.S. competitors, including Goldman Sachs [Group, Inc.], which has a 150 spread and Barclays with 105 basis points."

The market participant said that one problem with reverse convertibles in general is the small size of the coupon in proportion to the fee, especially when the annualized coupon has to be divided by four to reflect a three-month tenor.

Some firms have charged fees ranging from 3% to 5% for a reverse convertible, he said. For a 16% coupon, investors only get 4% on a three-month reverse convertible.

"That's not much when your fee is 3%," the market participant said.

"Here, the 1.5% fee is reasonable for a 3.87% coupon on three months. It's in line with other offerings.

"At the end of the day, it's really all about distribution. Regardless of what credit you are, what structure you're offering, if you have partners who are strong distributors, you'll have larger sizes.

"Otherwise you need your own internal distribution network, like Merrill Lynch or JPMorgan."

Spokespeople at BMO did not comment.

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