BMO Stops Selling Reverse Convertibles Tied to Single Stocks

Bank of Montreal has stopped selling reverse convertibles tied to single stocks, its most popular product in the U.S., as sales of the instruments fall to the least in two years amid regulators’ warnings of their risks.

“We are shifting our emphasis to index based reverse convertibles,” Alexis Brown, a spokeswoman for the Toronto- based bank, said in an e-mail, while declining to explain why the decision was made. “We are still in the reverse convertibles marketplace.”

BMO has sold about $250 million of the single-stock securities in the U.S. since its first offering in September of 2010, according to data compiled by Bloomberg. Its issuance of all types of reverse convertibles fell to $52.3 million in the first five months of 2012, down 40 percent compared with the year-earlier period.

U.S. sales of reverse convertibles, high-yielding bank bonds that convert into stock if a company’s share price plummets, declined to $204.6 million last month, their lowest level since at least the beginning of 2010, continuing a downward trend after a Financial Industry Regulatory Authority warning in July. The industry-backed regulator released an investor alert advising buyers to be wary of advertising suggesting the products are “safe and suitable for investors seeking high yields.”

Sales fell last month even as higher volatility allowed issuers to offer higher-yielding notes. The VIX, as the Chicago Board Options Exchange Volatility Index is known, averaged 21 in May, the highest level this year. The gauge measures the cost of options to protect against declines in the Standard & Poor’s 500 Index. Higher volatility boosts the value of derivatives embedded in reverse convertibles, allowing issuers to create more attractive notes.

Largest Sale

BMO last sold reverse convertibles on June 13, with 18 offerings linked to companies from Apple Inc. to Cliffs Natural Resources Inc., Bloomberg data show. Its largest U.S. reverse convertible, issued Jan. 7, 2011, was $7.54 million of three- month notes. The securities yielded an annualized 10.15 percent as long as any of the eight underlying companies didn’t fall below a pre-set barrier, according to a prospectus filed with the U.S. Securities and Exchange Commission.

In December, Wells Fargo & Co. (WFC) was fined $2 million by Finra for failing to supervise its top salesman of reverse convertibles from 2006 to 2008 as he recommended the products to elderly investors. Fifteen of 21 investors were more than 80 years old, Finra said in a statement.

Structured notes are securities created by banks, which package debt with derivatives to offer customized bets to investors while earning fees and raising money. Derivatives are contracts whose value is derived from stocks, bonds, currencies and commodities.

To contact the reporter on this story: Matt Robinson in New York at mrobinson55@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net.