Pricing on financial-linked products won't remain generous; JPMorgan links to BofA, Citi, Wells Fargo

By Kenneth Lim

Boston, April 21 - Financial names continue to be in focus in the structured products market as banks report their earnings, market observers said Monday.

Although a number of reverse convertibles linked to bank stocks have broken their barriers, products linked to financial names continue to draw significant interest from investors, a broker-dealer said. But terms now are unlikely to be as generous as the past few months, a broker-dealer said.

Blue Bell Private Wealth Management's J. Scott Miller said even structured investors who are not directly exposed to financial stocks are closely watching the results to assess their exposure to an issuer default.

The comments came as Bank of America Corp. said Monday its first-quarter profit fell a larger-than-expected 77% to $1.21 billion but said it had no intention of cutting its dividend.

Citigroup Inc. said it will raise $6 million in an issue of non-cumulative perpetual preferred shares, while Oppenheimer & Co. analyst Meredith Whitney wrote in a report that Citi may have to cut or stop paying dividends on its common stock.

Both names were included in a product launched by JPMorgan Chase & Co. JPMorgan plans to price a series of zero-coupon semi-annual review notes due April 29, 2010 linked to an equally weighted basket of the common stocks of Bank of America, Citigroup and Wells Fargo & Co.

The notes will be automatically called if the basket is higher than its initial level on any of the three review dates. If the notes are called, investors will receive par of $1,000 plus a call premium. The call premium will be at least 20.1% of the principal on the first review date, at least 30.15% on the second review date and at least 40.2% on the third review date. The exact premiums will be set at pricing.

If the notes are not called, investors will receive par at maturity as long as the basket is at least 90% of its starting level. Investors will lose 1.1111% of their principal for every 1% that the basket declines beyond 10% of its initial level.

Products linked to financial names remain interesting to investors, the broker-dealer said.

"Our best deal this month was actually linked to GE," the broker-dealer said. "I know that's not a pure financial name, but it's very similar...We do a lot of one-offs, I would say a significant portion of them are financial names. We've done [least-of products], you'll see tons of those."

But the broker-dealer said investors are unlikely to see terms as generous as they were last month and as recent as a few weeks ago.

"A lot of volatility has come in on the financial names so it's becoming a little harder to do the deals that you used to see," the broker-dealer said. "Right now in my mind [issuers] are going to give worse terms, now that earnings are out...if you look at all the volatility charts, you're not going to see the same amount of volatility as you did a few weeks ago, so you're not going to get the same kind of strikes and coupons as you would have gotten last month," the broker-dealer said.

The outlook on financials remains unclear, the broker-dealer said. Although investor interest remains high, the recent drop in volatility in the financial sector could affect demand. Issuers and distributors have also been keen to offer more diversified offerings.

"Our job is now to go and find new names, what's hot in the market," the broker-dealer said. "You try to take advantage of thematic ideas. The last six months or a year, bank stocks have been getting hit and we've done a lot of reverse convertibles on them...so now it's like what other stocks are not doing well?"

The impact of the financial sector extends beyond segments of the market that are directly exposed. At Blue Bell, which has been buying a lot of products linked to the broader S&P 500 index, the turmoil in the financial sector has more fundamental implications, Blue Bell managing partner and chief investment officer J. Scott Miller said.

"The concern that I have is to make sure that the credit of the issuer is sound," Miller said. "That's why we use many, many issuers and we're expanding our offerings to make sure we never overload any account with a single issuer."

Blue Bell closely watches the news coming out from the banks even though it mostly does not have investments solely tied to the financials, Miller said.

"It does affect us, but the effect comes in we don't ever want any one of these to blow up," Miller said.

The banking sectors' status as a broader market bellwether also affects the pricing of structured products across the board, Miller's son and Blue Bell managing partner Scott Miller Jr. added.

"When the financials come out with the good news, you tend to see less volatility in the markets," Miller Jr. said. "When it's not so good news you tend to see more volatility in the markets, so from a strategy perspective it affects pricing."

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