HSBC's notes linked to buffered return enhanced indexes offer unusual structure, advantages

By Emma Trincal

New York, Sept. 22 - HSBC USA Inc.'s $11.4 million of 0% notes due Oct. 6, 2011 linked to a basket of three buffered return enhanced components, although unusual compared to structures that blend several indexes in a basket, may offer benefits to investors, a financial adviser said.

The components are the Euro Stoxx 50 index with a 52% weight, the Topix index with a 24% weight and the FTSE 100 index with a 24% weight, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus the basket return, which will equal the sum of the weighted component returns for the basket indexes.

All in one

"This deal is different as they're rolling three structures into one," the financial adviser said, commenting on the payout structure.

If an index's underlying return is positive or flat, its component return will be double the underlying return, subject to a cap that varies for each index, according to the prospectus.

If an index's underlying return is less than zero but not less than negative 10%, its component return will be 0%. If an index's underlying return is less than negative 10%, its component return will be 0% minus 1.1111% for every 1% that the underlying return is less than negative 10%.

Cost-efficiency

"By not blending the performance of each index but instead calculating it separately, the issuer may generate cost savings," the financial adviser said. "And that may be passed along ... via either a higher cap or a better structure. If they use this cost-saving to give investors a better structure, that could be a plus for the end-user."

The cap is 19% for the Euro Stoxx 50, 6% for the Topix and 14% for the FTSE 100, according to the filing. Based on these caps, the maximum payout at maturity is $1,146.80 per $1,000 principal amount of notes.

Enhanced returns

Comparing this payout structure with the typical "blending" payout, the adviser said that investors may also score higher potential returns with this deal.

"I like this structure because it gives you more chances of benefiting from the buffer and more chances of doubling up the return," he said.

"When you do the blended index, one component can help you and one component can hurt you. With this, if one component goes down by more than 10%, it doesn't hurt you as much if the others don't," the adviser added.

Similarly, investors may gain greater benefit from the leverage on the upside even if the slight 1.11 leverage factor on the downside is one negative aspect of the structure, he said.

"Sure, each individual index may be more volatile than one. But with this deal, you're going to have more chances of using the leverage because one index could break the buffer while the other components may double up the gains, as opposed to the traditional structure, in which one index is up 10%, the other down 10%, which equals zero."

Correlation

A New York sellsider said that "it looks complicated, but it's interesting" while another sellsider said that the "structure was pretty standard."

"They're doing it differently, that's all, but it's not uncommon," the second sellsider said.

"They're packaging three structured product notes into one. You sell a 1.11 times 90 strike put that gives you the 10% buffer. They simply sell on three individual indexes, and they're using the money generated from selling the puts to buy the calls," this sellsider added.

He said that he wasn't sure whether this type of payout structure would work better for the investors than structuring three individual notes.

"Maybe they're looking to create a global equity market product," he said.

The financial adviser agreed and said that the notes were probably created to respond to a specific request.

"Whoever designed this must have done it for a special allocation need the client wants to play," the adviser said.

The adviser also pointed to the correlation between the components of the basket as one important aspect in gauging the efficiency of the structure.

"With blending, you get a better payout when the assets are not correlated," he said, adding that it may not necessarily be the case with the structure applied in the HSBC offering.

"I assume those three indexes are correlated," he said, adding that it could be another positive feature of the deal.

J.P. Morgan Securities Inc. is the agent.

Fees are 0.1%.

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