HSBC's $11.53 million notes tied to real offer appealing headline coupon with step-up digital

By Emma Trincal

New York, April 10 - HSBC USA Inc.'s $11.53 million issue of 0% barrier notes with step-up digital return due April 21, 2014 linked to the performance of the Brazilian real relative to the dollar was notable, sources said, due to a step-up digital structure combined with some partial downside protection.

The notes enabled investors to get a bullish exposure to the Brazilian real against the dollar with up to 15% protection on the downside, according to a 424B2 filing with the Securities and Exchange Commission.

The reference currency was the number of Brazilian reais per dollar.

If the reference currency return was greater than 3%, the payout at maturity would be par plus a digital payout of 28.5%.

If the reference currency return was greater than zero but less than or equal to 3%, the payout was par plus 5%.

If the reference currency return was down but not by more than 15%, the payout was par.

Beyond a 15% decline, investors would lose 1% for each 1% that the reference currency return was below zero.

Win Thin, senior currency strategist at Brown Brothers Harriman & Co., whose view on the Brazilian real is mildly bullish, said he liked the structure for its enhanced upside.

"We think the Brazilian real could appreciate slightly for the time being but not by much. What they give you is incredible. It's a very interesting product. I actually could have bought it. It's a no-brainer," Thin said.

Outperforming the real

"It's very levered up, and even if you can't get the 28% return, I think you could outperform a long position in the currency in a mildly bullish scenario," he said.

The Brazilian spot rate, currently at 1.97, would fall if the Brazilian real strengthened against the dollar as it would take fewer reais for the same dollar unit, Thin explained.

"The spot would have to drop to 1.91 approximately for a 3% increase. With the note, you get 5% for any currency appreciation between 1.97 and 1.91. That's already levered up," he said.

"But the biggest boost is above 3%. You would get a 28.5% return. In spot terms, that would require the rate to drop to 1.42. It's not going to go down that far, so you couldn't get that upside being long the real, but you have more chances to get there with the notes.

"Even if the chances of getting that type of payout are limited, what's nice about this product is that you're protected against any loss up to 15%. A 15% decline in the currency would be a spot at 2.27. That's a lot of protection.

"Your risk return is pretty good compared to a long position in the currency. It's definitely an interesting deal."

Step-up digital

A market participant said that this type of structure can be enticing for the headline coupon. It may not mean that investors are likely to get the higher digital payout, however.

"We've seen those types of structures. You get the consolation price if it's up moderately, up to 3%," he said.

"If it's up by more than that, you're getting a super bonus coupon of 28%.

"It's interesting in terms of the structure."

The issuer is using a different type of digital structure, one that may be more cost-efficient, or show better optics, than a standard digital, he said.

"What they do is they bump up your return into two tranches. The lowest one bumps up your return to 5% if you're between the 0% to 3% range. If you're over that range, they bump you up to the 28% bonus," he said.

"The bet is to get that huge bonus of course. But the reality is the investor is likely to get the FX appreciation available in the first tranche, the lower 5% digital, not the high bonus.

"So you're enticed into the deal because of the headline coupon, but the probabilities of getting this 28% bump-up are slim. It's not impossible, but it's less probable."

Single-currency bet

The deal was modest in size - although the second-largest one last week - perhaps due to the downside risk or the limited audience for that type of underlying, this market participant noted.

"The Brazilian real has become more risky. Brazil doesn't have the same growth potential it had two years ago. You wonder what the currency is going to do," he said.

"Brazil was doing well because it's a very commodity-rich country; it has good manufacturing, a lot of growth potential due in part to the Olympics and the World Cup coming up in a couple of years. We've seen that change in the last couple of months.

"It's also such a tactical deal; it's such a niche market. It's hard to imagine this deal on a larger scale. JPMorgan private bank probably has a large contingent of Brazilian clients who might be bullish on their own currency. It's a hedge for them," he said.

HSBC Securities (USA) Inc. was the underwriter and J.P. Morgan Securities LLC the agent, according to the prospectus.

The underlying asset class was also a factor in making the deal attractive, he added.

"Those types of structures sometimes are used with equities, but they are different. Sometimes you'll see step ups. You get a 20-year maturity with very high coupons in the last couple of years, but the chance of collecting those coupons is unlikely because the firm will call the notes," he said.

"This note, however, is only a one-year. That's definitely different from what you can price in equities.

"In part, it's because pricing in forex is much easier. It's a very liquid market. You can see pretty much what's going down the pike. It's much easier to transact than equities. You also have much more volatility. You can get big swings in forex similar to what you get when investing in single stocks."

The notes (Cusip: 40432XE56) priced April 5.

The fee was 1%.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.