HSBC’s $108.94 million leveraged notes tied to S&P Regional Banks: large bid may be Fed-driven

By Emma Trincal

New York, June 30 – HSBC USA Inc.’s $108.94 million issue of 0% Accelerated Return Notes due Aug. 26, 2016 linked to the S&P Regional Banks Select Industry index was seen as an unusually large deal for a not commonly used underlying, sources said.

But the underlying investment theme may resonate among investors anticipating some of the potentially positive effects of a Federal Reserve interest rate hike, they noted.

If the index return is positive, the payout at maturity will be par of $10 plus 300% of the index return, subject to a maximum payout of par plus 15.75%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will lose 1% for every 1% decline in the index.

BofA Merrill Lynch was the agent.

The S&P Regional Banks Select Industry index is designed to measure the performance of the regional banks sub-industry portion of the S&P Total Market index, an index that measures the performance of the U.S. equity market, according to the prospectus.

“Betting on the regional banks has to do with the anticipation that the Fed is going to raise rates, which will help net income,” said Dan Werner, a bank analyst at Morningstar who focuses on regional U.S. banks and Canadian banks.

Margin increases

“Most of those regional banks are flooded with cash. Unless there’s some kind of pressure, some kind of sign that their funding is going to leave, a rate hike will create a margin expansion for those banks,” he said.

That’s because while their cost of funding is likely to remain stable given the demand for deposits, their lending activity could be conducted at higher rates, he explained.

“Unless cash would start to leave the banks, those banks don’t have to pay more on their deposits short-term,” he said.

“Even recently regional banks have been growing deposits fairly fast. This is happening all across the board. Banks are flooded with cash. There are no incentives for them to pay more on deposits. When the Fed raises rates, they will see a big boost in their net income.”

While the same holds true for large banks, the benefits of a Fed rate increase would be more visible for regional banks, he added.

“It will be a bit more meaningful for regional banks because so much of their revenues depend on lending. The big banks run so many fee-based revenues centers – investment banking, wealth management – that for them, the impact of the Fed may be less significant.”

Not so common

Sometimes deals can be large in size when investors have no other access to the reference asset or asset class, noted a market participant.

But this was not the case for this deal, he added, pointing to an exchange-traded fund that tracks the performance of the underlying index, which is the SPDR KBW Regional Banking ETF.

“We don’t see that underlying index that often. It may be Merrill’s particular research view on this industry,” this market participant said.

“The regulators do not view regional banks as posing as much systemic risk as the large banks. Therefore, they are subject to less stringent capital requirements than their bigger counterparts. That for some analysts can be an advantage too.”

Citizens Financial Group, SVB Financial Group, Texas Capital Bancshares and Signature Bank of New York are some of the top 10 constituents by index weight, according to Standard & Poor’s website.

The S&P Regional Banks Select Industry index is up 4.13% so far this year versus 0.2% for the S&P 500 index. For the past 12 months, the regional bank benchmark has gained 12.50% versus over 5% for the S&P 500 index.

Mildly bullish

“This is for modestly bullish investors,” he said.

“They anticipate that regional bank stocks are going to go up short-term but it’s not going to be like ... the sky is the limit. Investors for that reason can tolerate a 15.75% cap over 14 months. With the leverage, if the index increases by 5.25%, you will receive your maximum return in 14 months. That’s 13.50% per annum.

“The note lets you take advantage of this story if it’s yours. Even if the index is up 2%, you’re up 6%.

“It’s not designed for strongly bullish investors. It’s for investors who see the sector moving sideways or moderately higher.”

The notes (Cusip: 40434G213) priced on June 25.

The fee was 2%.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.