HSBC’s leveraged notes tied to Euro Stoxx 50 offer no cap, timely play, but barrier is a risk

By Emma Trincal

New York, Oct. 27 – HSBC USA Inc.’s 0% barrier leveraged tracker notes due October 2017 linked to the Euro Stoxx 50 index may offer a value play – euro zone stocks were recently down – along with the benefit of a leveraged return with no cap, buysiders said. However, advisers looked at the barrier and the unpaid dividends as drawbacks.

If the index return is greater than zero, the payout at maturity will be par plus at least 135% of the index return. The exact upside participation rate will be set at pricing. Investors will receive par if the index falls by up to 20% and will be fully exposed to losses from the initial level if the index falls by more than 20%.

“Clearly, the upside, particularly the 1.35 times leverage without a cap, is nice because if you have a big gain, you’re not going to be capped out,” said Steven Foldes, vice chairman at Evensky & Katz/Foldes Financial Wealth Management.

“You get 35% more than the asset class. The 20% barrier is nice as well.

“Three years is in the acceptable range. The credit of HSBC appears to be fine.

“There are a lot of good things with the note.”

Timing, value

Andrew Valentine Pool, main trader at Regatta Research & Money Management, said that he likes the index from a technical analysis standpoint.

“Over the past three years, the ETF hit a low at around $27 on June 2012. Since then, it’s gone 37% higher. We generally take a look back at least three years and identify stocks that are not higher than their previous low by more than a third, which is roughly what we see for this one on the chart,” he said.

“If I now take a look at the short-term chart and check where the stock is trading in relation to its moving averages, I see that it’s lower than its 20-day moving average and it’s also under the 50 and 200 days, which is good. We like it when it’s below the average for the three periods.”

The moving average is a common technical analysis lagging indicator that measures the average of a stock price over a specific period of time. Twenty days, 50 days and 200 days are the most commonly used periods.

“If you like the Euro Stoxx 50, it looks like a very good structure at this point given that the index has declined over the last quarter. It’s also down by 8.5% since Sept. 18,” said Foldes.

“From a timing perspective, you’re not buying it where it was six weeks ago.

“From a valuation perspective, Europe and emerging markets are certainly inexpensive. Obviously, there is a reason. Based on the problems they’re having it’s reflected in the price, but these things can be reverted and you can get a pretty good bounce back. At those levels, it can be an interesting value play.”

Pool said he is bullish on euro zone stocks as an asset class.

“We like Europe on a three-year horizon. We think that long term, Europe is a good place to be,” he said.

“Countries in the euro zone obviously differ vastly from one to the other, with Spain, Italy, Greece, Portugal and Ireland on the riskier side.

“That’s why we would only make a small allocation, a 2% position.”

Another reason for being more cautious is the barrier on the downside.

“A 20% barrier is not bad, but we would like it to be slightly better. We would prefer a buffer even if the level of protection decreases in percentage. ... A 15% buffer if we had to pick would be preferable. Ten percent would be too low.”

Barriers, buffers

The contingency of the downside protection is also a concern for Foldes.

“With this note, if the index is down 21%, you lose 21%. If you had a buffer, you would only lose 1% all things being equal. An issuer would not give you a 20% buffer, we know that. But we have always preferred buffers, and we would prefer this type of protection because it’s real. It’s a sure thing, which the barrier is not. Once the barrier is broken, it can cost you more. If you get a real decline, you lose the whole thing,” he said.

Foldes said that he would prefer even a 10% buffer to the existing barrier.

“You could make an argument that if the losses are not extreme, you would be more protected with a barrier. For instance, a 15% decline would make you lose 5% with the 10% buffer and nothing with this 20% barrier. But we still prefer the buffer because you get a better protection if there is a correction,” he said.

“The idea of using a barrier is not as common to us. We’ve had barriers in the past, but we’ve primarily used buffers simply because it’s more attractive to our clients, and they know exactly what they get.”

Fat dividend

Pool pointed to another less attractive feature: the opportunity cost for investors having to forgo a dividend yield of 3.23%.

“Three percent is not a small dividend,” Pool said.

The S&P 500 index in comparison has a 1.87% yield, he noted.

“You’re giving up a lot. If you received three years’ worth of dividends, it would be about 10% in hard protection, the equivalent of a buffer,” he said.

“I’m ambivalent about the benefit of the structure – the leverage, the no cap in exchange for giving up that much in dividend. You get a barrier, but you’re giving up the equivalent of a hard buffer. I would have to do more research in order to evaluate the pros and cons and get a clearer idea of the risk-adjusted return.”

More gearing

Foldes said that he usually invests in enhanced return notes that offer more leverage than 1.35 times.

“We tend to do 1.5 to 2 times leverage. We understand that you have the benefit of not being capped. However, I might prefer a 2 times leverage factor even with a cap, as long as the cap is high enough. If you give me a 50% cap with 2 times leverage, I’d take it in a heartbeat,” he said.

“Overall though, this is an attractive structure. It’s a limited period of time; the bank is good; you get an uncapped index with leverage. All those things are positive. But we look at all aspects of the investment.”

The notes (Cusip: 40433BRM2) are expected to price and settle in October.

HSBC Securities (USA) Inc. is the underwriter.

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