Risk gap eases choice between ABN, Barclays reverse notes on Research in Motion, analysts says

By Emma Trincal

New York, Nov. 25 - The comparison between two reverse convertible products linked to Research in Motion Ltd. reveals that risk is one of the first thing investors need to look at when trying to choose between products with slightly different maturities but similar structures, said structured products analyst Suzi Hampson at Future Value Consultants.

"Risk is probably the most important thing for investors to consider. You want to think of how much return you're going to be left with," said Hampson.

The analyst looked at a three-month reverse convertible and a six-month, both linked to Research In Motion.

ABN Amro pays 12.65%

ABN Amro Bank NV priced on Tuesday 12.65% Knock-In Reverse Exchangeable notes due Feb. 26, 2010 linked to Research In Motion stock price.

The payout at maturity is par in cash unless Research in Motion shares fall below 70% 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 Research in Motion shares equal to $1,000 divided by the initial price, according to an FWP filing with the Securities and Exchange Commission.

Barclays at 13%

Barclays Bank plc priced on Monday 13% reverse convertible notes due May 26, 2010 linked to the same stock. The payout at maturity is par in cash unless Research in Motion 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 shares equal to $1,000 divided by the initial price.

Risk and value

"The biggest difference between the scores is riskmap and value rating," said Hampson, referring to two key indicators Future Value Consultants uses to rate deals.

The riskmap measures the risk associated with a product on a scale from zero to 10.

The value rating on a scale of zero to 10 is Future Value Consultants' measure of how much money the issuer spent directly on the assets versus other transaction costs such as direct fees and profit margin on the underlying derivative

Regarding risk, the three-month ABN Amro's riskmap is 3.01 versus 6.48 for the Barclays product.

The value comparison also shows a large gap, noted Hampson.

ABN's reverse convertibles have a value rating of 8.88 while Barclays' product shows a 4.17 score.

"Value takes into account estimated price, so it's not correlated to risk," said Hampson. "Those two indicators are not related. High value rating means that the issuer spent more money purchasing the assets than in fees, so it's a good thing for investors," she said adding that for instance an investor investing $100 in a product ideally would want to see the issuer purchasing $100 invested in assets.

"Although value is important to investors, risk is probably more important," she said.

"In this comparison the structure with the highest value turns out to be the one that has the lowest risk. But those two are not necessarily connected," she added.

Risk gap factors

Hampson said that the "substantial difference" in risk, with the three-month deal being much less risky than the six-month, was easy to understand.

"For the three-month, your capital is safe as long as the stock does not fall by 30%. For the other, it's double the time for a smaller barrier of 25%. The six-month structure gives you less protection over a longer period of time. The longer the length, the more likely the barrier is going to be hit," she said.

The difference in risk is reflected in the comparison of the two products' volatility. Hampson said that the annualized volatility of the underlying was 56% for the ABN Amro three-month deal versus 66% for the other and riskier deal.

Similar returns

One would expect the riskier deals to score a much higher return rating, said Hampson. But it is not so in this example, she added.

Return rating is Future Value Consultant's indicator, on a scale of zero to 10 of the risk-adjusted return of the notes.

The three-month, less risky structure offers a 2.80 return rating versus 2.89 for the six-month, according to Future Value Consultants' research.

"There is little difference, almost none between the two return ratings," said Hampson.

She noted that with the three-month deal, investors are getting a 12.65% coupon while they can expect to earn only 13% for investing their capital twice longer. "It's not that much higher considering that you're not getting the same level of protection," she said.

Easy choice

Taking into accounts those various indicators, especially risk, Hampson said the choice for investors was pretty easy to make when looking for a short-term investment.

"I would think that unless you particularly need a six-month product for specific reasons, the three-month scores better on all accounts. You get a lot less risk, for pretty much the same return and with more value," she said.

This result is evidenced by a noticeable gap in overall ratings between the two products, she noted.

ABN's overall rating is 6.37 versus 4.52 for Barclays' deal.

The overall rating, on a scale of zero to 10, is Future Value Consultants' opinion on the quality of a deal, taking into account costs, structure and risk-return profile.

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