HSBC’s notes due 2021 linked to Euro Stoxx 50 ETF seen as attractive for long-term buyers

By Emma Trincal

New York, April 25 – HSBC USA Inc. plans to price 0% market-linked notes due April 30, 2021 linked to the SPDR Euro Stoxx 50 exchange-traded fund, according to an FWP filing with the Securities and Exchange Commission.

If the ETF return is positive, the payout at maturity will be par of $10 plus the ETF return, subject to a maximum payout that is expected to be 153% to 163% of par and will be set at pricing. If the ETF return is negative, investors will lose 1% for every 1% that the ETF declines, subject to a minimum payout of 95% of par.

Terms

Ferenc Sanderson, principal at Elizabeth Park Capital Management, said the 53% to 63% upside maximum return is attractive. It represents 9% to 10.25% a year on a compounded basis.

Five years

There are some drawbacks, however.

First, the five-year duration with limited liquidity makes for a relatively long period of time during which investors cannot earn anything, he said.

The tax treatment of the notes may be a problem too, he added. Investors, according to the prospectus, are likely to pay ordinary income tax each year based on a “phantom income” even though no interest or dividend is received during the life of the notes.

“That’s an issue for some investors unless you invest in a retirement account. If you don’t mind the lock-up, that’s fine. But it’s definitely something people need to look at,” he said.

Dividends, cap

A second objection is giving up 3.2% of yield over five years, the equivalent of 16%. Investors in the notes must forego dividend payments.

The unpaid dividend represents the equivalent of a buffer on the downside and a minimum gain on the upside.

But giving up the dividends is the trade-off for getting 95% of the investment protected against market losses.

The notes carry a 3% fee.

Sanderson said the “fee is not egregious.”

As long as investors are comfortable with the long holding period and the tax treatment of the security, the notes may appeal to conservative investors who are “pretty nervous” about the market.

Tenor

Jerry Verseput, president of Veripax Financial Management, said the long duration would not be much of a problem for him in terms of liquidity. This frequent buyer of structured notes has no difficulties moving his clients out of existing positions if they wish to redeem early.

“My volume [of structured notes] is high enough, I could almost make my own secondary market on these,” he said.

“If a client wants to sell, I can often find another client willing to bid on the notes.”

However, the long tenor becomes a problem for investors who need income during the life of the notes.

The 95% principal protection is attractive, but he said he can find income alternatives with full downside protection offering the same kind of yield with leveraged steepeners, a type of products he invests in for income.

“A lot of steepeners are 10 times or 12 times. Even if the spread is flat, you can get pretty good returns,” he said.

“Besides, a flat spread doesn’t last too long.”

Some income products that put principal at risk may deliver high returns and give a comfortable level of protection.

He cited a five-year autocallable contingent coupon note linked the S&P 500 index and the Russell 2000 index with a worst-of payout. The notes pay the contingent coupon at a low barrier of 50%, which is at the same level as the point-to-point barrier for repayment of principal. The autocallable feature has the potential to cut the length of the investment, he said, while the high correlation between the two benchmarks and low barrier mitigate market risk. Finally the low coupon barrier maximizes the chances of creating income.

UBS Financial Services Inc. and HSBC Securities (USA) Inc. are the agents.

The notes will price on Wednesday and settle on April 29.

The Cusip number is 40434N333.

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