Barclays' 16% reverse convertibles linked to Fossil stock may need repricing, analyst says

By Emma Trincal

New York, June 15 - Barclays Bank plc's 16% reverse convertible notes due Dec. 31, 2012 linked to Fossil, Inc. shares fail to compensate investors enough for the market risk they are taking, said Gurdeep Ubhi, structured products analyst at Future Value Consultants, based on the ratings his firm assigned to the deal.

The payout at maturity will be par in cash unless Fossil shares fall below 75% of the initial price during the life of the notes and finish below the initial price, in which case the payout will be a number of Fossil shares equal to $1,000 divided by the initial price, according to an FWP filing with the Securities and Exchange Commission.

"The 16% coupon is much higher than the average coupon for six-month reverse convertible notes we've recently rated, which is 11.5%. And the 75% barrier is standard for that type of maturity. So it looks good on average," he said.

"But really, what matters with reverse convertibles is the volatility that comes into the equation.

"If the stock is very volatile, the chances of breaching the barrier increase, which may compromise your return. And that's exactly what we have here as the underlying stock is quite volatile.

"The issuer may have to reprice the deal, especially if volatility picks up."

Fossil

The stock of Fossil has an implied volatility of 50%, more than twice that of the S&P 500 index.

Fossil is a Richardson, Texas-based designer, marketer and distributer that specializes in consumer fashion accessories. Its stock price has fallen by 45% since the beginning of the month after disappointing first-quarter earnings.

"Obviously volatility rose, which is how they can afford to give you a 16% coupon," he said.

The riskmap is Future Value Consultants' measure of the risk associated with a product. The higher the riskmap, the higher the risk of the product.

Compared to all other reverse convertibles, whose average riskmap is 4.41, this note has a much higher level of risk with a 6.47 score.

The riskmap is the sum of two risk components: market risk and credit risk.

"In this case, the high risk comes largely from the market risk because the credit risk is the same as average," he said.

The market riskmap for this product is 5.88 versus 3.88 for all reverse convertibles.

"The risk is the result of market risk, which itself is a function of the underlying volatility," he said.

"Volatility has stabilized somehow from the beginning of May when the stock price suddenly collapsed, so arguably, now may probably be a better time to invest in this."

Risk versus reward

Future Value Consultants measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions: neutral assumption, high- and low-growth environments and high- and low-volatility environments. A risk-adjusted average return for each assumption set is then calculated. The return score is based on the best of the five scenarios.

In this type of product, the best assumption is low volatility.

The product's return score at 5.40 is substantially lower than the average of similar products at 6.09.

"Our score measures the risk-adjusted return. The low score indicates that the return they're offering is not enough for the amount of risk you're taking," he said.

One of the two terms, the 75% barrier or the 16% coupon, should have been enhanced, he said.

"They should have given investors either a higher coupon or a deeper barrier in order to compensate you for the risk you're taking," he said.

Value

The value of a product for an investor is measured by Future Value Consultants' price score on the same zero to 10 scale. The higher the score, the lower the fees and the greater value offered to the investor.

These notes show a price score of only 5.03, compared with 6.60 for other reverse convertibles.

"It's low and it comes back to volatility again. With a volatile stock like this one, you should get more value than this," he said.

But the product has not priced yet, he noted.

"This issuer still has time to change the deal. The coupon may increase. Repricing based on market conditions is very common with reverse convertibles. If volatility was to pick up, you would probably see in the final filing an increase in the coupon," he said.

The price score and return score are averaged to obtain the overall score of the product, which represents Future Value Consultants' opinion on the quality of a deal.

The notes have a 5.21 overall score versus 6.35 for reverse convertible notes in general.

"The overall [score] simply shows that other products are more competitive out there in terms of value and risk/return profile," he said.

The notes are expected to price June 26 and settle June 29.

Barclays Capital Inc. is the agent.

The Cusip number is 06741JG60.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.