HSBC prices No. 2 deal of year, $171.82 million notes linked to MSCI Daily TR Net World index

By Emma Trincal

New York, May 31 - JPMorgan sold the second largest deal so far this year on the behalf of HSBC USA Inc., a $171.82 million offering of 0% notes due June 14, 2013 linked to the MSCI Daily Total Return Net World index, according to data compiled by Prospect News.

The No. 1 offering was UBS AG, London Branch's $946.2 million 0% Fisher enhanced big cap growth securities linked to the Russell 1000 Growth Index Total Return, which also priced in May.

The HSBC notes track the underlying index, according to a 424B2 filing with the Securities and Exchange Commission. The payout at maturity is par plus the index return, with no downside protection and no return enhancement mechanism.

"It's a pure access play," a buysider said.

Private bank

When asked who may have bought the notes, sources agreed that it probably was a private bank deal.

"It's a retail product. This was for JPMorgan private bank. It's typical of them," a sellsider said.

"If it was an institution, HSBC would have sold it directly to the client.

"Those two banks [JPMorgan and HSBC] have very similar credits. It would be weird for an institution to go through two broker-dealers. It's just too complicated. It never works.

"It's definitely the private bank."

Executives at JPMorgan declined to comment.

Notes versus ETF

The MSCI Daily Total Return Net World index consists of 24 developed market country indexes. It includes the United States and Canada as well as several Western European countries, Japan and Australia among others.

"The size of the offering and the fact that it's not done on a very widely used index seem to imply that it's for a specific situation or client," said Matt Medeiros, president and chief executive of the Institute for Wealth Management.

The iShares MSCI World index fund, an exchange-traded fund, also offers exposure to this index, an industry source noted.

"Obviously, there is a reason not to use the ETF here, and one can only guess why," this source said. "Perhaps the rationale for doing it via a note as opposed to a fund is taxes."

The notes priced on May 25.

"It's more than one year. The notes are treated as prepaid forward. It's long-term capital gains as opposed to the ETF that treats the distribution of dividends as ordinary income," he said.

"To change the tax treatment from income distribution to long-term capital gain is certainly a benefit. That could explain why they did it, or at least that would make the most sense although it's not clear if that's the real reason."

His hesitation came from the fact that certain ETF sponsors can easily manage the distribution of income in ways that limit the tax burden for investors.

"There are ways to tax manage an ETF by buying the securities at different points in time or by selling to take a loss. The note is not systematically always a better solution," he said.

"But here, the note converts all the distribution into capital gains, so at least it has the benefit of clarity. It's not that clear cut with an ETF sponsor, especially when you don't know what tax policy they're going to follow."

Cost, errors

This source also ruled out the hypothesis of a single institutional client buying directly the notes for its own account. The 1% fee was one reason.

"JPMorgan probably did it for a discretionary account or for a bunch of high-net-worth individuals," this industry source said.

The ETF management fees are 24 basis points.

"If it was an institution, they could do a swap. It would be cheaper than 24 basis points probably," he said.

One advantage of a note over an ETF is to limit the extent of tracking errors, this source said, which could also explain the motivation behind the deal.

"I see for instance that this ETF has 20 basis points of tracking error since inception [in January] compared to the index. With the note on the other hand, HSBC is promising zero tracking error," he said.

Dividend mania

The two largest deals of the year so far happened to be linked to total return benchmarks. Total return indexes incorporate not only price but also income from dividends in the performance.

Medeiros said that dividend investing makes sense in uncertain times.

"Our largest allocation is to dividend-paying stocks, and those are often large caps, which is an asset class we focus on. Many of the large companies that pay dividends have healthy balance sheets. Dividends are also a way to reduce risk," he said.

"The dividend payout is probably the underlying theme in this deal," said Steve Doucette, financial adviser at Proctor Financial.

"More and more people talk about the benefits of high-dividend stocks. You hear it throughout the financial press. It's in the wirehouses with retail investors buying large-cap stocks that are often big dividend payers. It's a recurrent theme," Doucette added.

"In fact, I would start to be cautious at this point. When a trade becomes so crowded, folks tend to go to extremes, and it's always a good idea to consider taking a contrarian view," he said.

The notes (Cusip: 4042K1P49) were distributed by J.P. Morgan Securities LLC.

Data compiled by Prospect News does not take into account exchange-traded notes. It also does not include plain vanilla fixed-income products with light optionality such as step-up notes, step-down notes, fixed-to-floating notes and capped floaters.

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