HSBC's $69.04 million yield optimization notes on Bank of America show popularity of stock

By Emma Trincal

New York, Sept. 28 - HSBC USA Inc.'s $69.04 million offering of 10.34% yield optimization notes with contingent protection due Sept. 30, 2011 linked to the common stock of Bank of America Corp. highlight the popularity of Bank of America as an underlying for single stock-linked notes.

Most popular bank stock

So far this year, U.S. agents have used Bank of America as the underlying stock for $368 million worth of notes priced in 65 deals, data compiled from Prospect News shows. This represents nearly 1% of the overall $45.48 billion of structured notes sold in the year to date in the United States.

JPMorgan Chase & Co. comes next as a top underlying bank stock name, being used in $327 million worth of notes sold in 27 deals this year.

Wells Fargo & Co. is the third most widely used bank stock name with $165 mullion of notes tied to this security in 25 deals, according to data compiled by Prospect News.

Each note in the recently priced HSBC deal has a face value of $13.17, which is the closing price of Bank of America stock at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Interest is payable monthly.

The payout at maturity will be par unless the final price of Bank of America stock is less than 75% of the initial share price, in which case the payout will be one share of Bank of America stock per note.

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

As with all reverse convertible structures, the 10.34% annual coupon is designed to compensate investors for the risk of getting less than par at maturity as the shares of the underlying stock received then would be worth less than the principal amount, according to the prospectus.

The product targets income-seekers who believe that the stock will trend sideways over the one-year term, moving positively but less than the coupon paid on the notes or negatively but not below the buffer, the prospectus said.

"Clearly, this is attractive from a yield standpoint," said Frederick Wright, partner and chief investment officer at Smith & Howard Wealth Management. "But you have to have a strong understanding of the stock. We're not stock pickers but asset allocators, so we wouldn't be looking at reverse convertibles in general. If stocks were our forte, we might consider a deal like that."

Regarding financial stocks, whose overall value has declined by 14% since this year's peak in April as measured by the iShares Dow Jones U.S. Financial Sector index fund, Wright said that he did not have a view on the overall sector.

"Bank stocks could be valuable in this environment. Low interest rates can be good for banks' margins if they can make some loans. The question is: are they making enough business to make enough profit in this environment?" he said.

Third-largest deal

The HSBC deal, which priced last week, was the third-largest offering linked to Bank of America so far this year, according to data compiled by Prospect News.

The top one was issued in March by Morgan Stanley for $79 million. The second was also issued by HSBC, this time in the form of a $73.30 autocallable note also sold via UBS.

Overall, the top issuers of Bank of America-linked notes have been Morgan Stanley, HSBC and UBS AG with UBS and JPMorgan acting in some cases as agents for HSBC offerings, according to data compiled by Prospect News.

Volatility advantage

According to a sellsider, the reason behind the popularity of Bank of America as an underlier lies in one word: volatility.

"Bank of America is more volatile than other banks. So I assume it provides for higher coupons than other bank stocks," the sellsider said.

He looked at the historical volatility of Bank of America stock over the past 100 days, which is 40%, and compared it to other bank stocks, such as Citigroup Funding Inc., which has a 37% historical volatility; JPMorgan, which has a 34% volatility; and Goldman Sachs Group, Inc. with a 29% volatility.

"I think Bank of America as a stock is volatile because the business model of Bank of America has changed substantially since the acquisition of Merrill Lynch and there is still a lot of uncertainty as of to how they're building this franchise and how the earnings are positioned," the sellsider said.

The share price of Bank of America has fallen by nearly 12% so far this year, with the stock suffering the bulk of that loss since a peak in mid-April when shares traded at $19.50, versus $13.30 today.

Yet, the stock has been on the rise over the past month, noted Wright, which could be an indicator that the stock price is about to rebound.

"It's a volatile stock, but it's also been very volatile on the upside," noted Wright. "From its low at about $3.00 in the beginning of 2009, it has surged by more than a four-fold increase, which is a much stronger recovery than what you've seen with other bank stocks," he said.

"From a volatility standpoint, it's easier to do a deal on Bank of America because it's the most volatile of the banks. Probably the math makes more sense for the issuer," Wright said.

Bull impact

Another factor at play behind the popularity of Bank of America as an underlying stock is the bullishness on the part of some investors and lead analysts.

"Several factors explain why a reverse convertible deal is going to work or not," the sellsider said. "Certainly, high volatility translates into a higher coupon and possibly more interest. But I would also look at the source and see what type of research has been out there."

Among other star analysts, Betsy Grasek, who covers bank stocks at Morgan Stanley, is very bullish on the name and recommended two weeks ago Bank of America as one of the top bank stocks on Bloomberg Television.

The sellsider said that it's not uncommon for banks issuing or selling deals to have analysts in their own research divisions recommending the underlying stock. Any bullish view emanating from either the issuing bank or its agents as well as from other financial institutions is likely to have a positive impact on the size of the offering, he said.

"For some investors, it looks like the worst is over with Bank of America, that the stock is about to rebound, which is good. That's when it makes sense to buy," the sellsider said.

The fee for the deal was 1.75%.

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