UBS’ 14.03% trigger yield notes on Petrobras bring back to the forefront old revcon trade

By Emma Trincal

New York, Jan. 11 – UBS AG, London Branch in the pricing of 14.03% annualized trigger yield optimization notes due July 8, 2022 linked to Petroleo Brasileiro SA brought to market a small deal but also an unusual sample of what used to be one of the most popular structures a decade ago, now out of favor.

The size of the deal is $199,994.40.

Interest is payable monthly, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par unless the final price of Petrobras stock is less than 70% of the initial share price, in which case investors will receive one Petrobras share per note.

Best-sellers of the past

Reverse convertibles trades are short-term income-oriented notes that have lost their past popularity. The pricing reflects a short put position on a risky asset, with a high enough volatility to generate the necessary premium to pay a guaranteed and high-yielding coupon.

Those products, which tend to be tied to single stocks, have very short tenors (as short as three months) and no call feature.

Reverse convertibles used to be very popular a decade ago but have been replaced by callable contingent coupon notes. For instance, in 2011, callable contingent coupon notes and reverse convertibles had an even market share of approximately 12% each. Last year, reverse convertibles made for less than 1% of the total while callable contingent coupon notes captured more than 62% of it. This callable contingent coupon category includes Phoenix and snowballs.

High risk premium

“Obviously 14% a year, with a 7% guaranteed return in six months is very attractive. You’re getting eight times the 10-year Treasury return for a lot more risk,” said Tom Balcom, founder of 1650 Wealth Management.

“You have to have a view of the stock to be interested in this note though.”

Petroleo Brasileiro SA, or Petrobras SA, is the largest integrated oil and gas company in Brazil and one of the largest in Latin America. The firm is primarily engaged in exploration and production, refining, energy generation and trading.

“Investing in this note is a similar concept to high-yield bonds. If you want to add yield, you have to take on much more risk. If the market moves straight up, everyone is making money and they’re happy. If it’s not, it can blow up,” he said.

But a structured note adds another layer of risk compared to high-yield bonds.

“The credit risk is limited. But you have the market risk. It’s a single underlying. It’s a single stock. It’s a stock that’s highly volatile,” he said.

The implied volatility of Petrobras is 43.37% compared to 34% for the iShares Trust Global Energy ETF, which tracks global equities in the energy sector and to 18.5% for the S&P 500 index.

Business risk

“It’s always great to receive 14% a year until you face a black swan event,” Balcom noted.

This adviser said he sticks to equity indexes for the notes he purchases.

“I typically shy away from those types of products. You can sell it to a client for the yield. But if the client loses 30% or 35% at maturity, they’re going to be angry obviously. They’ll tell you: ‘you’re supposed to diversify my portfolio. Why did you do that?’

“The risk of losing money and clients is too high. I wouldn’t do it.

“The only case I would do it is if someone knew the company very well and felt confident about investing in it.”

Discount price

Another financial adviser said he liked the risk-return tradeoff.

“It’s fairly attractive to get 7% in six months. You don’t want to lose more than 30%, which of course is possible,” he said.

“Too bad you’re getting cash back and not shares in case you breach the barrier.

“It wouldn’t be the end of the world to own the shares at maturity because the company has upside potential. But if you take a straight 30% loss or more, that’s a little bit different,” he said.

The note is not designed for bullish investors.

“You don’t need to be a bull. But you can’t be a bear,” he said.

This adviser is not bearish on the Brazilian stock market – on the contrary.

“It’s an out-of-favor asset class at the moment. The stock itself has declined drastically. At least you’re not overpaying,” he said.

The initial share price of Petrobras’ stock was $11.28 on the trade date, setting the trigger price at $7.90. From a five-year high of $18 in March 2019, the share price has declined by 39%.

Risk reward

“You could look at the risk profile and say: a 14% maximum return for a possible loss of my entire investment is not worth it. But you also have to consider the probabilities of losses,” he said.

“The chances of a 30% drop are limited given that Petrobras has already been hammered.

“So, while you could lose a lot of money on this trade, the odds are in your favor.

“To me, it’s a reasonable tradeoff.”

UBS Financial Services Inc. and UBS Investment Bank are the underwriters.

The notes settled on Thursday.

The Cusip number is 90302P183.

The fee is 1%.

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