Constant supply, high risks, low scores likely hurt demand for Wells Fargo product: analyst

By Kenneth Lim

Boston, May 1 - Issues specific to the underlying asset were probably behind low sales for a recent reverse convertible linked to the common stock of Wells Fargo & Co., said structured products analyst Suzi Hampson of Future Value Consultants.

JPMorgan Chase & Co. recently priced $80,000 of 16% reverse convertible notes due Oct. 30, 2009 linked to Wells Fargo shares, one of the smallest deals this year. With par at $1,000, only 80 notes were sold.

Payout at maturity will be par in cash unless Wells Fargo shares fall below the protection price, 50% of the initial price of $20.30, during the life of the notes and finish below the initial price, in which case the payout will be Wells Fargo shares equal to $1,000 principal amount divided by the initial price.

Lackluster scores

In a research note, Future Value gave an overall rating of 1.97 out of a best possible 10 to the product. A risk score of 8.13 out of the riskiest 10 was also assigned.

The overall rating is based on a value score, which is Future Value's assessment of the total costs taken out from the product from direct fees and profit margin on the underlying derivative; a return score, which is the firm's estimation of the potential returns on the product; and a simplicity score, which reflects an opinion on the complexity of the product.

Hampson noted that despite a good chance of getting more than a 15% return from the investment, investors are almost as likely to lose more than 5%. And because the barrier is 50%, when it is breached investors are likely to lose a significant amount of their capital.

"This one has not done very well on our value or return ratings," Hampson said. "That's probably not unlinked to how much was sold."

Looking beyond terms

The product is also rather risky, which may have put off some investors.

"The terms tell you it's going to be risky," Hampson said. "It's a 50% barrier, a coupon of 16%. An investor should look at this and think this is a risky product. If they don't, they should look again."

But Hampson reckons that the deal was affected by more than investors' risk tolerance, because a rather risky product offered through the same prospectus sold considerably more. She was referring to a 20% reverse convertible due Oct. 30, 2009 linked to the common stock of Freeport-McMoRan Copper & Gold Inc. with a barrier at 40% of the initial share price that sold $362,000 through JPMorgan.

"There must be something that makes investors want to invest in that stock rather than Wells Fargo," Hampson said. "It must be down to the underlying."

Because reverse convertibles are so common and they are offered so frequently, investors who do not feel comfortable about a particular underlying stock this week can simply hold out a few more weeks for the next calendar offering, she said.

"They just churn them out," she said.

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