Barclays' 9% reverse convertibles tied to Peabody Energy have above-average risk, lower coupon

By Emma Trincal

New York, May 13 - Barclays Bank plc's 9% reverse convertible notes due May 17, 2012 linked to the common stock of Peabody Energy Corp. offer low potential returns for above-average risk, said Suzi Hampson, structured products analyst at Future Value Consultants.

The notes received a low price score, which means that the issuer "should have been able to offer a higher coupon" based on the deal's terms, she said.

The payout at maturity will be par in cash unless Peabody Energy shares fall below 80% 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 Peabody Energy shares equal to $1,000 divided by the initial price, according to an FWP filing with the Securities and Exchange Commission.

Risk and term

"This will appeal to investors seeking a decent income over a period of one year," said Hampson. But she noted, "The majority of reverse convertibles we rate are much shorter, typically three months in term."

The longer the maturity, the greater the risk with reverse convertibles, she said, because the chances of breaching the barrier are greater.

However, the increase in risk is not proportional to the duration, she said.

"If you look at the same deal and compare a three months with a 12 months, the 12 months is not four times more likely to hit the barrier. It's not linear," she said.

Riskmap - a Future Value Consultants rating that measures the risk associated with a product on a scale from zero to 10 - is 6.06 for this product.

Future Value Consultants just upgraded its rating system and now offers an average per product type that can be used as a benchmark for each type of structure. For the average reverse convertible, riskmap is lower than 6.06 at 5.60.

"The duration is one factor. Also the implied volatility of the stock while not among the highest is still high at 36%," she said.

Another new feature introduced by Future Value Consultants is the breakdown of riskmap into two components: credit risk and market risk. On both scores, this product's risk is higher than the average reverse convertible.

Below-average return score

The combination of higher risk and a somewhat low coupon, said Hampson, resulted in a return score of 4.77, which is below the 5.73 average for reverse convertibles. It is also lower than the 6.18 average for all products.

The score reflects the probability table of product return outcomes, which shows a 25% chance of losing more than 15% on this product that caps potential gains at 9%, said Hampson.

On the gains side, the greatest probability bucket is a nearly 60% chance of generating a positive return comprised between 5% and 10%, which with this deal would be between 5% and 9%, she said.

This bucket is the greatest because it includes two scenarios, said Hampson.

"It's either you're getting your 9% coupon with your principal back or you get a lower gain. But it's still a gain because the stock decline is less than 9%," she said.

In other words, the coupon may be seen as a cushion from a total return standpoint, she said.

"This is the big difference between a reverse convertible and a growth product. With a reverse convertible, even if you breach the barrier and if your index ends up lower than at the beginning, you may not incur a loss," she said.

Low price score

In its new system, Future Value Consultants replaced its former "value score" with a new "price score," but the concept stays the same.

Based on a scale of zero to 10, the rating represents the real value to the investor after deducting the costs the issuer charges in fees and commissions on an annualized basis.

"The higher the price score, the more the issuer spent on the assets rather than the fees," said Hampson.

These notes received a "very low" price score of 0.87, she noted. The average for this type of product is nearly 5.

"This must be pricing badly in comparison with similar structures. It suggests the issuer should have spent more on options in order to give the investor a higher coupon," she said.

The overall rating, on a scale of zero to 10, is Future Value Consultants' opinion on the quality of a deal taking into account riskmap, price score and return score.

The notes received an overall score of 2.82 versus an average of 5.32 for deals of a similar structure and 6.19 for all recently rated notes.

The notes were expected to price Friday.

Barclays Capital Inc. is the agent.

The Cusip number is 06741JHJ1.

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