UBS' $18.48 million issue tied to U.S. Steel among largest of recent reverse convertible deals

By Emma Trincal

New York, Oct. 25 - UBS AG, London Branch's $18.48 million sale of yield optimization notes with contingent protection linked to the common stock of United States Steel Corp. was a well-received reverse convertible offering last week in a market that has seen fewer issues with that structure lately.

UBS' issue was by far the largest of the 14 reverse convertibles priced last week, according to data compiled by Prospect News.

The second-largest one - also brought to market by UBS and linked to Adobe Systems Inc. - priced for $6 million.

"It's a very good size. UBS is a big organization. They may have an analyst who has a very strong opinion on the stock. Or they may have had one or two big clients," said Tom Livingston, director of structured products at Halliday Financial Group, a registered investment advisory firm and broker-dealer.

He noted that for investors long the underlying stock, a reverse convertible offering may be an opportunity to add more protection to the portfolio. "It's definitely an equity alternative that gives you some protection."

The notes linked to U.S. Steel stock have a coupon of 11.95% and mature Oct. 26, 2011, according to a 424B2 filing with the Securities and Exchange Commission.

The notes have a face value of $43.08, which is equal to the closing price of U.S. Steel stock at pricing.

Interest is payable monthly.

The payout at maturity will be par unless U.S. Steel stock finishes at less than 75% of the initial share price, in which case the payout will be one share of U.S. Steel stock per note.

Coupon as compensation

Like any typical reverse convertible, investors receive the 11.95% coupon "regardless of the performance of the underlying stock," the prospectus said.

The coupon is designed to give investors income but also to "compensate [investors] for the possibility that [they] could lose some or all of [their] principal," according to the prospectus.

Investors have to hold the view that the stock will trend sideways and agree not to participate in the stock's potential growth in exchange for the protection, explained Ian Lowes, managing director at Lowes Financial Management, a financial advisory firm.

"It's a fairly straightforward one-year reverse convertible," he said.

"You basically sell a put option for less risk.

"It has the same effect as selling a put. You get your premium from the bank. The bank buys the put for 12%. And if the stock falls by 25% or more, you are forced to buy the stock."

Cyclical stock

However, Lowes said that he would not invest in the notes because they are an "option on a single stock." He would prefer a diversified, broad index.

"This is an investment for stock-picking advisers. We're more inclined to get exposure to major indexes. With a reverse convertible note, you definitely have to be a stock-picker, without a doubt, which we're not," he said.

The stock performance of U.S. Steel has been declining. At $42.27 (NYSE: X), the share price is down 23% in the year to date and nearly 40% lower than an April peak.

Livingston did not comment on the underlying stock itself but rather looked at the stock's category and sector.

"Cyclical stocks are stocks we would stay away from. And steel stocks are a proxy for global GDP growth. We think the overall economy will grow by 1% to 2% - if that - over the next two years.

"That said, having a 25% protection may be sufficient."

Livingston's main objection to the deal was its one-year tenor.

"I would be more inclined to go for a shorter maturity, preferably a three-month deal. I wouldn't stick my money for one year," he said.

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

Fees are 2%.

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