Bank of Montreal's 19.85% reverse convertible on ATP Oil & Gas offers high coupon but is risky

By Emma Trincal

New York, March 31 - A reverse convertible note announced by Bank of Montreal offers an attractive coupon, but the high volatility of the underlying stock makes this investment too risky for a limited upside, a financial adviser said.

However, given the short term of the notes and based on a positive view of the energy sector, the risk is worth being taken, said another adviser.

Bank of Montreal plans to price 19.85% annualized reverse exchangeable securities due July 20, 2011 linked to the common stock of ATP Oil & Gas Corp., according to a 424B2 filing with the Securities and Exchange Commission.

Interest will be payable monthly.

The payout at maturity will be par unless ATP shares fall below the trigger price - 75% of the initial share price - during the life of the notes and finish below the initial share price, in which case the payout will be a number of ATP shares equal to $1,000 divided by the initial share price or, at the issuer's option, the cash value of those shares.

High volatility

Steve Doucette, financial adviser at Proctor Financial, said that he has never been comfortable with reverse convertibles, but this one in particular is particularly risky given the wide price swings of ATP Oil & Gas.

"This is a stock that went from $42 in June 2008 to $3 less than a year later in March 09. You're talking about a more than 90% decline in price. It's pretty volatile, I would say," he said.

ATP Oil & Gas acquires and develops natural gas and oil properties and produces natural gas and crude oil, primarily in the outer continental shelf of the Gulf of Mexico.

The stock price is up 8% year to date. Over the past 12 months, the share price lost 3.72%. The stock closed down 1.8% at $18.11 (Nasdaq: ATPG) on Thursday.

ATPG Oil & Gas has a 2.74 beta. Beta is a measure of the volatility of a security in comparison to the market as a whole. A beta of one means that the stock will move with market prices, and a beta higher than one indicates potentially higher returns but more risk.

Full downside risk

Doucette said that the 75% barrier was helpful. In addition, the nearly 20% annual coupon makes for a 5% return for the three-month period, which may be seen as an additional cushion to protect investors on the downside. Yet, he said that risk remained too high.

"The 5% in addition to 25% helps. But that's if the stock doesn't go down too much. But a 25% drop with such a volatile stock is not out of the question," Doucette said.

His main objection was with the risk/reward profile of reverse convertibles in general, he said.

As stated in the prospectus, investors could lose "up to the entire principal amount" of their notes.

"My mind shuts off when I hear about reverse convertibles as a concept. You have a full equity risk exposure with a limited coupon. I'm never going to look at that," he said.

Good opportunity

Others, though, are confident about the outlook for energy and see in the deal an attractive opportunity to capture yield.

"I don't have a view on the stock itself. But I believe that oil prices, while they may not go much higher, at least will stabilize," said Matt Medeiros, president and chief executive officer at the Institute for Wealth Management.

"Demand may drop a little bit because of Japan. Prices may be choppy. But I don't believe in a 25% drop over the next three months.

"And since I don't see much growth on the upside, it makes the 20% coupon particularly attractive."

Adding that the coupon, which is paid regardless of the stock performance, is the equivalent of a cap, he said, "I see gas and oil trading sideways. So there's less risk of breaching the barrier on the downside while the odds of hitting the cap on the upside are slim.

"I think it's a good risk/reward profile."

The notes (Cusip: 06366QEW3) are expected to price April 15 and settle April 20.

BMO Capital Markets Corp. is the agent.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.