Buysiders criticize lack of protection in HSBC’s $50.81 million gears tied to S&P 500

By Emma Trincal

New York, Dec. 7 – HSBC USA Inc.’s $50.81 million of 0% capped gears due Jan. 31, 2025 linked to the S&P 500 index probably drew a heavy bid for the high leverage on the upside. But buysiders rejected the full exposure to market losses, especially with a capped upside.

The payout at maturity will be par of $10 plus triple any index gain, up to a maximum return of par plus 14.85%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will be fully exposed to any index decline.

Mildly bullish

Steve Doucette, financial adviser at Proctor Financial, analyzed the cap in relation to the high leverage factor.

“You’re not really bullish here. You just believe that the market is going to be up 5%, or marginally over that since it’s a 14-month,” he said.

On an annualized compounded basis, the notes are capped at 12.6%, a level achievable if the index rises 4.95% per year.

“You don’t want to be capped out. So, the market should be up less than 5%, that’s really what you believe,” he said.

“I don’t call that a bullish note.”

New highs

The lack of any downside protection over a 14-month period had to be addressed. Doucette would modify the terms.

“I would add some protection first. In order to do that, I would lower the leverage a bit,” he said.

Last month brought the market into a new direction, making the protection all the more necessary.

From Oct. 27 to Dec. 1, the S&P 500 index jumped 12%. Doucette raised the prospect of a reversal.

“My FOMO sentiment needs a bottom. Right now, we just had such a runup I would be a little bit more defensive,” he said.

“Everybody says the market will hit new highs next year. We don’t know that.

“I would add a buffer first, and if I can push the cap up, all the better.”

Full downside risk

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said that the 3x leverage was probably not the most essential component of the structure even though it probably contributed to the success of the trade.

“The leverage doesn’t replace a buffer or a barrier even if it allows you to free up capital,” he said.

“The leverage will simply enhance your return while minimizing your capital outlay.”

For Medeiros, the absence of any downside protection was a “deal-breaker.”

“I’m taking the credit risk, and I don’t have any protection. This would not be something I would consider,” he said.

The leverage could be obtained in different ways, he noted. A leveraged ETF may achieve the same goals on the upside although the symmetrical exposure would multiply the losses by the same multiple, which would be a disadvantage.

“There are other ways. I could buy call options if I want the asymmetrical leverage,” he said.

Sacrificing the protection in order to boost the leverage was not an attractive tradeoff for this adviser.

The 2% fee disclosed in the filing was an additional problem.

“When you look at some pretty complex structures you may understand the higher fees. In this case, I don’t see a 2% complexity fee.

“Over a 14-month period, 2% is pretty high. This is not a note I would be interested in,” he said.

Fee

A buysider said he did not like the risk-adjusted return of the investment.

“You’re taking all the equity risk for a pretty modest return. It’s equity replacement for the portfolio. But these are not the kinds of notes we do for equity replacement,” he said.

On the positive side, returns from the 14-month note would benefit from a favorable tax treatment.

“It’s longer than one year, so it’s long-term capital gains. You’re not getting any coupon. It’s equity replacement from a tax standpoint, no question about it,” he said.

But equity replacement and equity were not the same thing, he said.

“When we think equity replacement, we think buffer or barrier, some kind of downside protection to overcome the fact that we’re taking credit risk. The 14.85% cap on 14 months is too low to justify a non-buffer,” he said.

Also, investors are giving up about 1.8% in dividend yield over the term.

“You’ll be down 1.8% no matter what,” he said.

The 2% fee over the 14-month period was “surprisingly high,” he said.

“That’s the yield-to-broker.”

He repriced the notes, eliminating the commission.

“With a 0% fee, all things being equal, you should probably be able to get 17% or better on the cap,” he said.

The size of the offering was also a “surprise” to this buysider.

“It’s huge. It’s discouraging to me that a deal like that could be that popular,” he said.

UBS Financial Services Inc. and HSBC USA Inc. are the agents.

The notes settled on Nov. 30.

The Cusip number is 40441B510.

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