Outlook 2007: Reverse convertibles, equity-linkeds to make up structured products landscape in 2007

By Sheri Kasprzak

New York, Dec. 29 - Reverse convertibles and equity-linked securities will most likely make up the majority of offerings presented in the structured products arena in the coming year, much as they did in 2006, market sources told Prospect News in their forecasts for the year to come.

The reasons these deals will be popular vary from ease of use to investor interest in profit to the standardized structure of the securities.

"Things like reverse convertibles are very popular right now because most of the investors [in structured products] are Baby Boomers who are looking to make money," said one equity structurer based in New York in a recent interview.

"They want things that will put money in their pockets rather than just paying back their investment or paying a percentage of their investment. The coupons are very appealing to them for that reason."

Still another market source said that, unlike many other types of structures in the market, reverse convertibles do have some standardization.

"Obviously a lot depends on the reference stock and a lot depends on market conditions and whatnot, but you'll generally have a knock-in price between 70% and 80%," he said.

"Generally, you're going to see just one stock linked to a reverse convertible, you're going to have a set coupon, you're going to have all of the pieces there.

"With a lot of these [structured products], the biggest rule is that there are no rules. [With reverse convertibles] there could be a huge range of coupons, but that's going to depend on your reference stock."

More standardization?

Even though structured products securities outside of reverse convertibles or other equity-linked structures have little standardization, the landscape could be changing if JPMorgan Chase & Co. has anything to do with it.

The investment bank recently proposed setting up a classification system to the Structured Products Association that, according to JPMorgan, could provide more transparency for investors. The proposed program would separate prospective investments by features.

Keith Styrcula, chairman of the association, said in a recent interview that the time has come for standardization in the structured products marketplace because of the rapid growth of the market.

"This industry is growing and there is a tremendous upsurge in investor interest," he said.

"Along with that comes the responsibility of the industry to provide transparency and clarity to the investors. With structured products, you have an added element of complexity that other markets don't have."

Trials in January

A pilot program is expected to start sometime in January. The pilot program will include JPMorgan, Goldman Sachs & Co., UBS AG, Morgan Stanley and others with six additional investment banks to join later in 2007, according to Keith Styrcula, chairman of the Structured Products Association.

"The U.S. is fairly new to structured products," said one equity structurer in a recent interview. "For that reason, it's kind of a free-for-all in terms of structures and how these deals get put together. It can get very complicated."

Styrcula agreed with this summary as the reason investment banks have, in the past decade, relied upon proprietary names for their products.

"Most structured products in the past decade have been sold in proprietary channels," Styrcula said. "Investment banks were forced to come up with clever acronyms and marketing names."

Products to be categorized

Under the terms of the proposed standardization system, one term will be used to refer to items from Group A, which includes principal-protected products, partial principal-protect products, buffered principal at-risk products and principal at-risk products. Then the investment banks will pick a description of their products from Group B to be used with the Group A descriptions. Group B includes synthetic convertibles, reverse convertibles, dynamic allocations, periodic cappeds, target returns and synthetic exposures.

One term will be picked for description in Group C, which includes straight participation, averaging participation, variable participation and enhanced participation. Group D will refer to either a variable, fixed or minimum return coupon and Group E will refer to the callable or auto callable status of the products.

Coming up in 2007

Styrcula estimates the growth of structured products in 2007 over 2006 will be about 40%, which compares with a remarkably accurate forecast of 25% growth for 2006 over 2005 that Styrcula said he had anticipated at the end of 2005. There were about $50 billion in structured products offerings sold in the U.S. in 2005 and Styrcula estimates $70 billion in deals were closed this past year.

"I'm not going to make any estimates but I do expect more than this year," said one equity structurer when asked about his forecast for the coming year. "I think we'll see the standard reverse convertibles, probably more [equity-linked securities] and maybe more in the way of things like [certificates of deposit]."

Still, Styrcula doesn't feel that structured products will really take off until investment advisors recognize them as a legitimate investment product.

"How soon the market will double depends upon how soon the mainstream press treats [structured products] as an investment class as much as other investment classes," he said.

"Growth will occur when investment advisors embrace these products. When we start targeting investment advisors and those advisors seek out these products for their clients, that's when the market will double."

Styrcula said he feels that is likely to happen within two years.

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