Barclays, JPMorgan, Morgan Stanley price reverse convertibles; structure's sales still thin, distributor says

By Kenneth Lim

Boston, July 13 - Investor interest in reverse convertibles remains thin amid persistently high market volatility and small risk appetites, a structured product distributor said.

Barclays Bank plc priced about $50 million of reverse convertibles on Monday, with each series averaging about $5 million in size. JPMorgan Chase & Co. priced about $0.75 million of reverse convertibles in four deals, while Morgan Stanley sold $1.5 million from one deal.

"It's definitely not the same market that we were looking at two years ago," the distributor said.

Reverse fortunes

Reverse convertibles continue to be a significant portion of the structured notes business, but volumes have shrunk by more than half from a year ago, the distributor said.

The downtrend came with the onset of the financial crisis in 2008, when concerns about the credit quality of issuing banks and about the outlook for the equity markets formed a two-pronged attack on reverse convertible sales, the distributor said. Reverse convertibles, which are usually senior unsecured obligations of the issuer, pay a regular coupon and will return par at maturity as long as the underlying does not fall below a barrier during the life of the notes and does not end below its initial level.

"You couldn't make them attractive enough," the distributor said. "Investors just didn't want to touch them with a 10-foot pole. Nobody knew how far the markets were going to fall, so none of the barriers looked like they were big enough. Nobody knew if the issuers were still going to be standing the next day, so none of the coupons were high enough."

Reverse convertible sales have not recovered to those levels partly because markets remain highly volatile, the distributor said. Investor risk appetites also have not returned.

"There's still a lot of cautiousness in the market," the distributor said. "It's not something that's unexpected. A lot of investors lost a lot of money over the past year, and it's very natural that they'll be more careful with how much risk they're taking on."

Structured certificates of deposit are also helping to make it easier to forgo the potentially higher returns of reverse convertibles, the distributor said.

"A lot of the business has moved to CDs," the distributor said. "We've definitely seen a lot of growth in that sector...I think when you can get potentially equity-like returns on an FDIC-insured product, there's definitely less of a need to take on a higher-risk investment just to get a better yield in our current low-rate environment."

Slow return

Some of the pressure on the reverse convertible market could be easing, the distributor said.

Market volatility has been declining over the past few months, which could remove a barrier for cautious investors to add on exposure to equities.

Fears of issuer defaults have also come down considerably from the peak at the end of 2008.

"There's a lot more confidence today about the financial institutions than in November of last year," the distributor said.

But any recovery in reverse convertibles could be slow, the distributor added.

"I do think some of the changes that have affected us over the past few months won't go away so quickly," the distributor said. "I think principal protection will continue to be the main focus for a lot of investors and investment advisers at least for the near to medium term. When the markets begin to do better and investors feel more comfortable with the underlying assets and with issuers, they'll start to look for alternatives that can pay better yields, but it's not something that's going to happen overnight. You don't go from being a guy who never drives above 50 miles per hour on the highway one day to a daredevil who's speeding at 90 miles per hour the next day."

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