Harris's cliquet CDs generous, but maximum payout unlikely, analyst says; HSBC notes seen as attractive

By Kenneth Lim

Boston, March 6 - Harris NA's planned certificates of deposit linked to the S&P 500 index offer a generous return cap, but investors are unlikely to reach the cap because of a cliquet feature, said structured products analyst Suzi Hampson of Future Value Consultants.

Meanwhile, a principal-protected note from HSBC USA Inc. appears to offer good value at a relatively low risk, Hampson said.

Harris plans to price zero-coupon principal-protected certificates of deposit due March 31, 2014 linked to the S&P 500 index.

The payout at maturity will be par plus the sum of the index returns in each of the five years making up the life of the CDs. The return in each annual period will be capped at 11.5%, and the minimum payout at maturity will be par.

The maximum return on the CDs is 57.5%, but the cliquet feature makes hitting that cap less likely than a product that simply compares one start value and one ending value, Hampson said. The difference lies in the likelihood of the underlying index providing a consistent performance throughout the life of the notes, she explained.

"It's a good payoff," Hampson said. "But for this product to really pay off, ideally you'd want the index to rise by 11.5% every year for five years, and you've only got one valuation point per year as well, so that's quite unlikely. If you back-tested it...it'd be quite interesting to see what you would get in the end. I don't think the likelihood of getting anywhere near the cap is high just because you would need the index to continually rise."

One bad year for the S&P 500 could also affect the payout even if the index ends up higher than its current level, she noted.

"The fact that the bottom isn't floored, if it falls by 25%, it's going to take at least two years of very high growth to get back," she said. "For principal-protected products a maximum of 57.5% sounds quite appealing, but obviously it's a little more complicated."

But the product probably would not look as attractive if not for the cliquet feature, Hampson said.

"Breaking it up into digital points is how they can offer it with such a high cap," she said. "Offering principal products now is quite hard because volatility is so high."

HSBC notes get good grades

HSBC's planned zero-coupon principal-protected Global Opportunity Notes due Sept. 30, 2014 linked to a basket of three equity indexes scored well in Future Value's assessment system.

The basket comprises equal weights of the S&P 500 index, the Dow Jones Euro Stoxx 50 index and the Nikkei 225 Stock Average.

If the basket finishes above its initial level at maturity, investors will receive par plus any index gain, subject to a maximum total payout of 145% to 155% of the principal. Investors will receive at least par.

The HSBC notes received an overall 7.6 rating out of a best possible 10 from Future Value. Its risk rating was a low 1.4 out of a riskiest 10, reflecting the principal protection.

Noting that the cap on the HSBC notes was not too far off from the Harris cliquet CDs, Hampson reckoned that investors would prefer the HSBC structure.

"I think this would price better than the cliquet," Hampson said. "It's not capped year on year, and you're only capped on the whole rise. And...they've used three indices, which helps decrease volatility."

Getting the maximum payout on the HSBC notes will likely be easier than with the cliquet CDs, she said.

"Even though the cap on the other product is higher, the possibility of hitting the cap is much lower on the cliquet," she said.

HSBC is likely able to offer the product because the 5.5-year tenor is relatively long, Hampson said.

"It's quite a long-term product," she said. "Principal-protected products now, you have to take it to a longer term if you're going to offer anything attractive at all. Plus they capped it."

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