HSBC's, Barclays' big knock-out issues linked to S&P 500 said to reflect craving for yield

By Emma Trincal

New York, June 22 - Two of the largest recent deals, a pair of capped knock-out notes sold by JPMorgan, suggest that investors are actively looking for yield, a sellsider said.

HSBC USA Inc. priced $46.26 million of 0% knock-out buffer notes due June 27, 2012 linked to the S&P 500 index, according to a 424B2 filing with the Securities and Exchange Commission.

Separately, Barclays Bank plc priced $40.18 million of 0% capped market plus notes due July 5, 2012 linked to the S&P 500, according to another 424B2 filing with the SEC.

With both structures, a knock-out event occurs if the index's closing level falls by more than 20% during the life of the notes.

If a knock-out event occurs, the payout at maturity will be - in both deals - par plus the index return, which could be positive or negative. Otherwise, investors will receive par plus the greater of the index return and a minimum return.

The minimum return is 2.35% for the HSBC notes and 3.1% for the Barclays product.

Whether a knock-out event occurs or not, the return will be capped at 20% in both deals, according to the filings.

The 1% fee is the same in both offerings.

Good deals

"These aren't bad on a one year," a New York sellsider said.

"Look, people are trying to do better than money market rates. Getting a minimum of 2% or 3% if you don't think the S&P is going to fall as much as 20% isn't bad."

This sellsider said that the market will be choppy for the next 12 months but that a 20% decline is unlikely during that time.

"I think the summer is going to be pretty bad, but the market will go back up toward the end of the year.

"If you think that we're up for a rebound early next year, then it's a nice way to play that view. I think they're pretty good deals."

Risk is real

Kirk Chisholm, principal and wealth manager at NUA Advisors, agreed that yield was probably what lured buyers into those deals as they both offer a contingent minimum payment.

But to him, the payment is contingent upon an event that could very well happen, making the notes all too risky.

"If people look for yield, there are better ways to get it than something like that," he said.

Chisholm said that he predicted at least a 10% sell-off in the next 12 months.

"Depending [on] what's happening in Greece, a 20% drop is not inconceivable," he said.

"Considering the risk in Europe, the probabilities of the knock-out event happening are high enough that I don't think this investment would be a good fit for me."

Risk/reward

Chisholm added that the risk-versus-reward profile of both notes was not very attractive.

"You're taking a lot of risk for simply getting the same return as the S&P," he said.

"It's reasonably likely that the triggering event will happen, which will eliminate the 2.35% or 3.1% minimum return and will give you the S&P 500 return," he said.

In addition, the upside is capped, which makes the notes even less attractive than being long the market, he noted.

Chisholm said that the observation period used for the determination of the occurrence of a knock-out event was also a concern.

"The probability of a 20% decline would be much lower if it was calculated point to point. The fact that the index just has to hit the threshold once at any time doesn't make me feel comfortable," he said.

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