HSBC's Leveraged Index Return Notes linked to Dow seen as appealing despite five-year tenor

By Emma Trincal

New York, Dec. 2 - HSBC USA Inc.'s 0% Leveraged Index Return Notes due December 2018 linked to the Dow Jones industrial average offer an uncapped upside with a buffer on the downside, two features sources said are appealing despite the notes' five-year maturity and the unspecified leverage factor. The simplicity of the payout is also seen as a benefit to investors.

The payout at maturity will be par of $10 plus 100% to 120% of any index gain, with the exact participation rate to be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 20% and will be exposed to any losses beyond 20%.

Upside

"I would look at 100% participation differently from 120%," said Michael Kalscheur, financial adviser at Castle Wealth Advisors.

"But you have hopefully some level of leverage and no cap on the upside.

"You also get a solid buffer on the downside. It's not a cliff, meaning it's not a barrier. You have 20% that are actually protected against losses."

Even if the upside participation rate ends up being 100%, which would mean that the structure would offer no leverage on the upside, the notes would remain attractive, said Carl Kunhardt, wealth adviser at Quest Capital Management.

"Even if it's one-to-one on the upside, it's not a bad upside. There is no cap. You're not worse off than being long the equity, plus you get a 20% downside protection. If they make it at 1.2 times leverage, that just makes it more attractive," Kunhardt said.

Straightforward

These advisers particularly like the lack of complexity in the structure.

"It's simple, straightforward, easy to understand. Everybody knows what the Dow Jones is. Would I rather have the S&P? Yes, but the Dow is still a very well-known index; it's worthwhile," Kalscheur said.

"There's not a lot going on behind the scene, and I actually like that. When a deal takes more than 30 seconds to explain, I don't even want to look at it," Kunhardt said.

"This one is tied to an index for five years, point to point. It's 1.0 to 1.2 on the upside. It has a 20% buffer, no cap. It's a pretty transparent benchmark. I like it," he said.

For Kalscheur, a non-complex structure is a good way to gauge the value of an investment as investors know what to expect and can easily assess the results.

"Some people are just going to look at it and say it's pretty plain vanilla. Well, I like plain vanilla. It makes a lot of sense. We haven't seen a lot of plain-vanilla deals lately, and it's too bad. Clients are better served having simple, easy-to-understand, straightforward structures," Kalscheur said.

"Sometimes you can be your own worst enemy by trying to be too fancy.

"For instance, I'm not a fan of those autocallables that have a lot of moving parts and conditions. If you get A, then you can get B, but it's necessary to have C. Those complicated products are not necessarily going to meet clients' expectations.

"But a simple structure like this one is easy to understand. And just as importantly, clients know what to expect. At the end of the day, if it works, the client can say, Great, it did exactly what it was supposed to do," Kalscheur said.

Combining a 20% buffer with an uncapped upside is perhaps the most attractive feature of the deal.

"No cap: That's what I really like about it," Kalscheur said.

"When you talk about the long term, and five-year is pretty long-term, I worry about the creditworthiness of the issuer and the cap. Since you don't have a cap and hopefully some leverage built into it, this looks really interesting.

"In terms of creditworthiness, it's HSBC. They're excellent. It's by far one of the strongest banks out there. It makes me feel really good."

HSBC USA is rated A+ by Standard & Poor's.

Five years

The longer maturity is the trade-off enabling investors to benefit from the attractive aspects of the structure, the advisers noted.

Kunhardt noted that in today's market, five-year products are no longer unusual.

"Five years is a little long, but it is what it is. You're not getting good deals with shorter terms anymore," he said.

"I've noticed that lengths are getting longer. I typically don't want to go out beyond five years, although we've done a couple of seven-year [deals], but those were special types of deals. In general, we try to stay between three and five years, but we're finding fewer three years. Most have gone four to five years. I suppose it's because in this interest rate environment, they have to hedge out the risk by going longer."

Given the recent new highs in the equity market, the five-year term may actually "work in your favor," Kunhardt added.

"Even if there is a market downturn, it's unlikely that in a five-year term, it would work against you," he said.

"We'll have a correction at some point. But if it happens sooner, for instance in 2014, you still have four years, and we've seen that four years was enough to get past 2008.

"If it happens, let's say a year before maturity, you already had a four-year run up, and since the starting point is fixed, it's the initial date, you have plenty of upside to protect you.

"It would be different if it happened closer to the end, for instance in the third year. But it's probably unlikely."

For Kalscheur, the longer-dated product may be more suitable for some clients.

"Five years is a long time to tie up your money, but when clients understand what they have and how it helps them, in my experience, they don't mind," he said.

"For a 40 or 50 year old that has money in an IRA that they won't touch for 30 to 40 years, what's wrong with having 1% in long-term-focused structured notes?

"This might be on the long end of our structured notes ladder, and we'll supplement that with shorter products."

Overall, the structure itself offers enough protection to attract a wider range of investors concerned about the possibility of an imminent downturn, he noted.

"I'm still a long-term bull on the market even as it is right now," he said.

"If you do have direct exposure, the Dow is at 16,000. It protects you on the first 20% of 16,000. That's more than a 3,000 drop.

"Not only is it uncapped with potentially some leverage, but if the Dow drops 3,000 points tomorrow, you're still protected.

"I think most clients would ask, Where do I sign up for that?

"If I was a raging bull, that downside protection would be less valuable. You didn't need downside protection in March 2009.

"But it's much more appealing today for anybody who is a little nervous about where the market is heading. It's smart. This is one of the reasons we do invest in structured products. You're locked in for five years, but you have this 20% downside protection."

Fee

While Kunhardt considers the 2.5% fee "pretty normal," Kalscheur said he would probably try to push it down.

"Really, the only downside - and that's not a deal breaker - is the fee," he said.

"Over five years though, it's only 50 basis points a year. I'd love to get it lower, and maybe it can be done, I don't know. We've done it before as a registered investment adviser as we're fee-only."

The issuer offers a discount of 5 basis points, decreasing the fee to 20 bps for accounts in the amount of $5 million or more, he noted, referring to the prospectus.

"But these are for individual accounts only. It would be a big commitment for retail. So we would just have to negotiate. We think that with the offering price, we do have some wiggle room.

"Even with the 50 basis points a year, it's not too much to give up for a really nice deal. We'll definitely be considering it," he said.

The notes are expected to price and settle in December.

BofA Merrill Lynch is the agent.

© 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.