HSBC's annual income opportunity notes on nine ADSs offer tech exposure, 8.75% annual cap

By Emma Trincal

New York, Aug. 5 - HSBC USA Inc.'s upcoming annual income opportunity securities with auto cap due August 2016 linked to a basket of American Depositary Shares may appeal to investors seeking principal protection with a coupon tied to the performance of a basket of foreign stocks.

The basket, which has a strong weighting in technology and telecommunications, includes the ADSs of Canon Inc., China Unicom (Hong Kong) Ltd., Chunghwa Telecom Co., Ltd., CNOOC Ltd., ICICI Bank Ltd., LG Display Co., Ltd., Nippon Telegraph and Telephone Corp., SK Telecom Co., Ltd. and Tata Motors Ltd.

Interest is payable annually and will equal the average of the performances of the basket ADSs, subject to a floor of zero, according to an FWP filing with the Securities and Exchange Commission.

If a basket component's return is zero or positive, its performance will be fixed at 8.75%. If a basket component's return is negative, its performance will be the ADS return.

The payout at maturity will be par.

Principal protection

One of the attractive features of the deal is the 100% principal protection at maturity, subject to the issuer credit risk, sources said.

While a certificate of deposit would enjoy further protection with insurance from the Federal Deposit Insurance Corp., sources noted that this issuer's credit is attractive.

HSBC is rated AA- by Standard & Poor's, AA by Fitch Ratings and A1 by Moody's Investors Service.

"They have the lowest CDS out there, which is a positive," said Steve Doucette, financial adviser at Proctor Financial.

"The 8.75% cap sounds good if you compare this to a CD for the same term," said Robert Castellano, president of the Information Network, an equity research firm specializing in technology stocks.

"This could be a decent play to collect some income," Doucette said. "It could be used for diversification purposes and as a small piece of a portfolio."

Diversified basket

Another advantage is the basket itself, which is made of growth stocks from foreign countries.

"While a lot of the stocks are in technologies, the basket is still quite diversified," said Castellano. "You have telecommunications, wireless, imaging and cameras, but also oil and banking. These are strong companies, and the diversification reduces the risk of losses."

Canon sells various machines such as copiers, laser printers and cameras.

China Unicom (Hong Kong), Chunghwa Telecom, Nippon Telegraph and Telephone, SK Telecom and Chunghwa Telecom are telecommunications services or equipment providers.

CNOOC is an oil and gas company.

ICICI Bank is a financial services firm.

LG Display is a manufacturer of thin film transistor liquid crystal display panels used in televisions and computers.

Cap and floor

The main risks associated with the notes come from the 8.75% cap, said Doucette. More significant, he said, is the fact that investors could end up earning no interest during the entire period since the coupon varies and is based on the basket performance.

"You don't know what your coupon is going to be. We're in [a] volatile, cyclical bear market. You could earn anything between zero and 8.75%," he said.

Doucette said that the 8.75% cap on the basket performance "is not bad."

But he added that he would not be buying the notes for his clients because he rarely invests for more than three years given the uncertainty of the interest-rate environment.

Time factor

Doucette said that many investors "desperate for yields today" make their investment decisions based on what rates are today.

"They're not seeing that rates could move up in the future. Five years from now, rates could be 7% or 8% on that term," he said.

Doucette said that long-term investments represent risks associated with the value of time.

"There is an opportunity cost," he said. "We never know what interest rates are going to be, and locking in money for six years may or may not make sense."

The notes (Cusip: 4042K04V4) will price and settle in August.

HSBC Securities (USA) Inc. is the agent.

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