HSBC’s trigger gears linked to Euro Stoxx 50 offer mid-teens annualized cap for various bulls

By Emma Trincal

New York, Sept. 26 – HSBC USA Inc.’s 0% capped trigger gears due Sept. 30, 2019 linked to the Euro Stoxx 50 index feature a relatively attractive cap, buysiders said. But depending on their view on European stocks, this cap is either too much or not enough.

For moderately bullish investors who don’t expect enough index growth to make the cap a realistic target, money could have been better spent elsewhere on other terms. At the opposite end, those who foresee a potential uptick in European valuations, so far lagging U.S. stocks, said the cap is too limiting.

If the index return is greater than zero, the payout at maturity will be par of $10 plus 2 times the index return, subject to a maximum return that is expected to be 53% to 59% and will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index declines by 30% or less and be fully exposed to the index’s decline from its initial level if it declines by more than 30%.

International bucket

Carl Kunhardt, wealth adviser at Quest Capital Management, said the notes are “attractive.”

“First, I approach this note as any others from the financial planner standpoint,” he said.

“I’m always going to need between 10% to 15% or 25% to 30% of non-U.S. core. Europe is the 800-pound gorilla when you think international allocation. There’s no way around it.”

Protection

Secondly, Kunhardt said the notes offer a “good” level of contingent protection.

“I would want a good substitute to the index, which to me means risk mitigation,” he said.

Europe is facing many headwinds from Brexit to slow economic growth, he noted, adding that political risk, immigration, fiscal deficits and concerns about the banking system add to the uncertainty.

“The downside takes priority when I look at a note linked to the Euro Stoxx. This one has a 30% protection. That seems very fair. I don’t envision a scenario in which Europe would be down 30%,” he said.

“The Euro Stoxx can knock around unattractive returns, but I don’t see it dropping 30% three years from now.

“I think 30% is a good barrier.”

Cap is fine

Kunhardt said he likes the structure because the “good” protection does not translate into low upside potential. On the contrary, the cap in his view is generous to the point of almost being unrealistic.

The range of 53% to 59% represents a compounded annualized return comprised between 15.23% and 16.72%.

To achieve such gains, the index would have to rise 8.15% to 9% on a compounded basis each year, which he said is very unlikely.

“I’m not concerned about the cap because you’re not going to hit the cap, so I don’t care,” he said.

“With two-times leverage, I’m more likely to get 9%-10%, which is what we hope to get for stocks anyway.”

Credit

Other good features include the three-year duration, which Kunhardt classifies as “intermediate,” not long-term.

The credit of the British bank is also compelling.

HSBC has credit default swap rates of 72 basis points versus 97 bps for Barclays, according to Markit.

Its spreads are also better than most U.S. banks, including Goldman Sachs with 96 bps; Morgan Stanley, 93 bps; Citigroup, 80 bps and Bank of America, 79 bps, according to Markit.

“There is no credit concern with this issuer, which is nice. It’s always something you need to look at,” he said.

Lackluster returns

Steven Foldes, vice-chairman at Evensky & Katz/Foldes Financial Wealth Management, expressed a more bullish view, arguing that the cap should be raised based on the potential rebound in European stocks.

He pointed to the recent performance history of the index.

In 2014, 2015 and so far this year, the Euro Stoxx 50 has posted negative returns of 8.36%, 4.26% and 5.60%, respectively. Last time the benchmark showed a positive return was in 2013 with 27.43%, still underperforming the S&P 500 index by five points.

“This is your traditional downside protection and leveraged note. It’s a bit longer than we would like, but it’s not bad,” he said.

Increasing the cap

“The cap is higher than I have seen.”

But Foldes said he would prefer an even higher cap.

“I would give up some leverage for a higher cap, particularly if you’re bullish because Europe has not had a tremendous run.

“You had almost three consecutive years of a down index.

“If you believe in the return to the mean, the idea of wanting to participate more in the upside makes sense.”

Foldes said he would be willing to decrease the leverage to 1.5 or 1.75 if he could increase the cap.

It would be “very difficult” to bargain for a shorter maturity at the same time, but he would still want to shorten the notes if he could.

Buffer

On the downside, Foldes did not object to the size of the protection but to its type.

“Having a 30% barrier is attractive, but I’d rather have a hard buffer even if it’s smaller,” he said.

If he decided to customize the notes, he would chose a 15% to 20% buffer over the current barrier.

The main parts of the structure are “attractive,” he said, but to consider it, Foldes would want more upside potential via the higher cap and the “certainty” of a buffer as opposed to a barrier.

UBS Financial Services Inc. and HSBC Securities (USA) Inc. are the agents.

The notes are expected to price Wednesday.

The Cusip number is 40435B775.

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