Barclays links to basket of four bank stocks; structure reduces volatility of erratic sector, adviser says

By Kenneth Lim

Boston, Jan. 22 - Barclays Bank plc's planned reverse convertible linked to a basket of financial stocks could alleviate the risk of being linked to a single financial stock, an investment adviser said.

"A basket of four stocks would tend to be less volatile than a single stock," the adviser said.

Barclays plans to price a series of 18% reverse convertibles due July 30, 2009 linked to a basket of four bank stocks.

The basket comprises equal weightings of Bank of America Corp., Wells Fargo & Co., JPMorgan Chase & Co. and The Goldman Sachs Group, Inc.

At maturity, the notes will pay one-quarter of par for each component stock unless the component stock closes below 50% of its initial level during the life of the notes and finishes below its initial level. For each component stock that meets those two conditions, investors will instead receive a number of shares of that stock equal to one-quarter of par divided by the initial stock price.

Structure eases risks

The grouping of the four bank stocks into a basket helps to reduce some of the volatility that would normally be associated with any one stock, the adviser said.

"When you put the stocks in a basket, because they're not perfectly correlated, you'd expect that the basket's volatility is going to be lower than each of the component stocks, just like the S&P 500 tends to have a lower volatility than its component stocks," the adviser said.

That reduced volatility could be valuable given the high volatility of banking names, the adviser said.

"Putting them in a basket could make it more digestible for investors," the adviser said. "Volatility in all those stocks are so high now we just don't want to touch anything in financials right now. Every time I see something that's linked to the banks, I think, 'Who's buying this stuff?'

"But I suppose if you price it right, you can get people to buy anything. Maybe this could tip the balance a little so that some investors will be more comfortable with investing in the space."

The notion that the issuer could be trying to keep underlying volatility low for this product is also reflected in the choice of component stocks, the adviser said.

"Those are what would be considered the less risky banks at this moment," the adviser said.

Low barriers

The adviser noted that the 50% protection barrier is rather generous.

"It's an annual 18% coupon, about 9% for six months, and the 50% barrier is quite low," the adviser said. "If you're bullish on these stocks for the next six months, this could be interesting. It's a high coupon and if you're confident that the stocks are going to go up, that 50% barrier will look very good."

But the terms are also reflective of the highly erratic underlying stocks, the adviser said.

"One year ago those terms would have been great, people would be piling into them," the adviser said. "Now that coupon is still very attractive, but the barrier doesn't look that low because the volatility of those stocks is just so high."

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