HSBC’s 9.5% one-year STEP Income notes tied to Under Armour offer high income from high flyer

By Emma Trincal

Sept. 28 – HSBC USA Inc.’s 9.5% STEP Income Securities due October 2016 linked to Under Armour, Inc. shares offer an appealing coupon for yield seekers, but the downside risk and potential opportunity cost on the upside should be taken into consideration given the strong performance of the underlying stock.

Interest will be payable quarterly.

If Under Armour stock finishes at or above the 109.5% step level, the payout at maturity will be par of $10 plus the step payment of 1% to 5%, according to an FWP filing with the Securities and Exchange Commission.

If the stock gains by up to the step level, investors will receive par.

Investors will be exposed to any losses.

High flyer

“You get a fixed return of 9.5% and possibly more if the stock is up 9.5%. There is no participation. It’s an income play based on a very aggressive stock,” said a market participant.

“I don’t know. ... If I was going to be on Under Armour, I would want to own the stock. You buy the stock when you think it’s going to be up 20% or 25%, or you don’t because you think it’s going to be down 20%, 25%.

“This is a high-flying stock. Under Armour is pure growth. If you buy the notes, you really want the stock to stay in a limited range. If it’s up a lot, you lose. If it’s down, you lose.

“Assume the extra income is 2.5% above the step level. So that’s a 12% return total if you get above the 9.5% threshold. Twelve percent versus a stock that’s already up 50% for the year.

“I guess you could see this income play as a safer way to play the stock because you do get the 9.5% protection on the downside, but this is a company that’s growing so fast. They’re constantly moving into new markets. I suspect they will continue to grow at a rapid rate. That’s why I really would want to own the stock as opposed to this income-producing paper.”

Downside risk

Jack Ablin, chief investment officer of BMO Private Bank, stressed the risk factor.

“It’s full downside risk. In a way it’s like picking up nickels in front of a steamroller,” he said.

“It’s suited for the income client perhaps, but there is generous income with equity risk.”

Marc Gerstein, research consultant with Portfolio 123, said he does not like the risk-adjusted return of the notes.

“It’s not a real play on Under Armour,” he said.

“Usually with these products you can often say that it’s a different way to play the stock or the index. But in this case, both sides are so radically altered.

“Under Armour is a decent company, but the stock is very much overvalued. It looks like a momentum play on a high-growth company.

“If I like the company, I can take a gamble on the stock.

“But if I cap the upside, I want to have a cap on the downside too.

“I’m not going to go asymmetrical, not with these valuations.

“The company made big acquisitions recently. There are too many opportunities for things to go wrong, causing the stock to trade less a year from now.

“I would pass.”

BofA Merrill Lynch is the agent.

The notes will price and settle in October.

© 2015 Prospect News.
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