HSBC's $54.2 million notes linked to S&P 500 topped last week's list with enticing upside

By Emma Trincal

New York, July 5 - Several factors helped make HSBC USA Inc.'s $54.2 million of 0% Accelerated Return Notes due Aug. 30, 2013 linked to the S&P 500 index the largest deal of last week, according to sellside sources.

The payout at maturity will be par of $10 plus triple any index gain, up to a maximum return of 17.31%. Investors will be exposed to any index decline, according to a 424B2 filing with the Securities and Exchange Commission.

Bank of America Merrill Lynch was the agent.

Upside potential

"It makes sense that it would be the best-selling deal," a structurer said.

"It has the largest distributor with Bank of America. HSBC has a fairly good credit rating. The S&P [500] is the most popular underlying, and it has a short-term maturity."

The structurer noted that investors are familiar with this type of bullish product with no downside protection.

"It's the kind of structure that Bank of America has been selling for a long time," he said.

The product, with its three-to-one upside exposure and 17.31% cap, would appeal to bulls, he said, while the one-to-one downside exposure with 100% of the principal at risk can only be suitable for investors with a stomach for risk.

"This is nice on the upside. Say you have a 9% return at maturity, which is about what we have year to date. ... Three times that and it's 27%. That's above cap, but you still get 17%. That's not bad compared to 9%," he said.

"You can see it as an alternative to buying the SPDR if you're bullish and have a certain risk tolerance.

"You have the same downside exposure, but on the upside, you have that extra leverage plus a high cap."

Cloning the past

A wirehouse source said that the HSBC offering last week mimics past successful deals, adding that investors stick to what works.

"A lot of those deals, one-year, 18-month, were done last year, and they showed pretty good returns," he said.

The S&P 500 has increased a meager 2.4% since 14 months ago. With this performance multiplied by three, however, investors in a similar note would have gained 7.2%, outperforming the benchmark significantly, he explained.

"It's a repeat deal. Those deals performed well, so people want to do it again," he said.

Not worth it

But a financial adviser said that he sees no value in that type of structure.

"I don't understand why you would buy a note with equity risk and leverage but no downside protection, especially when your return potential is capped," said Matt Medeiros, president and chief executive of the Institute for Wealth Management.

"Why would you introduce more risk, with the credit risk, in addition to market risk?

"With downside protection, I would take the credit risk. But without it, taking full equity exposure without getting the full return in addition to taking on the credit risk, that makes no sense to me."

According to Medeiros, the absence of any leverage on the downside is not a good enough feature to offset the drawbacks he pointed to.

"Having a cap on the upside doesn't compensate you for the additional credit risk. I'm not seeing any advantage," he said.

Cost is also an issue as the fees for the notes are 2%.

"If I want exposure to the S&P, I can look at the SPDR. It's only 9 basis points," he said.

"The fund has a 9 basis points fee, no cap, no credit risk. I don't think leverage is worth the additional credit risk and expenses."

The notes (Cusip: 40433M674) priced on June 28.

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