UBS sells $34.04 million reverse convertibles tied to Ford; low interest rates help structure

By Kenneth Lim

Boston, Sept. 16 - Reverse convertibles dominated the structured products headlines on Thursday as the structure continued to attract attention in a low-interest-rates environment.

UBS AG, London Branch led the day's new issues with a $34.04 million offering of 10.09% yield optimization notes due Sept. 20, 2011 linked to the common stock of Ford Motor Co.

At maturity, investors will receive par of $11.98 per note unless Ford's share price ends below $8.99, which is 75% of the initial price. If the underlying stock finishes below the trigger price, investors will receive one Ford share for each note.

The UBS structure is slightly different from more common reverse convertible structures, which typically return shares or equivalent cash to investors if the trigger has been breached during the life of the notes and the underlying finishes below its initial value.

"On the face of it, the UBS structure is better for investors because you can still get back your principal even if Ford shares do terribly in the fifth month, for example," an investment adviser said. "In a reverse convertible, you could lose your principal if Ford shares cross the barrier during the term and end below their starting price."

Low yields

Reverse convertibles can be tempting for investors when interest rates are low, as they are right now, because they feature high coupons, the adviser said.

"There are a few issues here that tend to make them attractive to retail investors," the adviser said. "First, the coupons look really good when you're getting under 1% for a one-year CD. Second, the barrier creates the appearance of lower risk. Third, many investors feel more familiar and comfortable taking a short-term position on an individual stock than taking a longer-term view on a basket of stocks."

But the adviser does not usually recommend reverse convertibles to clients because they are usually riskier investments.

"It's almost like trying to make money by constantly buying and selling, which I generally don't advocate," the adviser said. "I believe in buying and holding, to a certain extent, so I'm usually looking at things where I can express a longer-term view."

The reverse convertible structure is also a little complex, and some investors could have trouble understanding the products, the adviser said.

"It's hard to figure out how much these things are really worth," the adviser said. "I could try to recommend it to someone, but I wouldn't feel comfortable unless they fully understood why I'm recommending it and what they're getting."

Filling a niche

But the reverse convertible can be useful for some investors, the adviser added.

For investors who are prepared to invest directly in certain volatile stocks, a reverse convertible can reduce some of the downside exposure.

"Most of the time you're getting a very good coupon and enjoying a bit of protection against a sharp drop in the underlying shares," the adviser said.

Investors do have to give up some of the upside if the underlying increases more than the coupon, but the coupons are usually nothing to scoff at.

"So I don't make a 15% return because I didn't buy the stock, but I still got 10%, which is very respectable," the adviser said.

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