HSBC’s 54- to 57-month leveraged capped notes tied to S&P 500 aimed at mild bulls

By Emma Trincal

New York, June 27 – HSBC USA Inc.’s 54- to 57-month 0% leveraged capped notes linked to the S&P 500 index may appeal to investors who only anticipate very modest returns in the U.S. markets, a financial adviser said.

The longer tenor and cap may on the other hand deter the more bullish type of investors.

If the index return is positive, the payout at maturity will be par plus 305% to 315% of the index return, subject to a maximum settlement amount that is expected to be $1,610 and $1,630 per $1,000 principal amount of notes, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will lose 1% for every 1% that the index declines beyond its initial level.

The exact maturity date and maximum settlement amount will be set at pricing. Depending on the final terms, the annualized cap will be within a 10.55% to 11.50% range on a compounded basis.

Subdued expectations

“If you believe in modest returns, this note is for you,” said Steven Foldes, vice-chairman of Evensky & Katz / Foldes Financial Wealth Management.

“If you see 3% or 4% a year, you multiply that by more than three-times leverage, that’ s a significant leverage and a much better return than what you anticipate.”

But based on historical data, the odds to outperform the benchmark were slimmer.

Over long periods of time, the S&P 500 index has generated average annual returns of about 9% to 10%, he said.

In the past two years, however, the S&P 500 index has gained less than 2%. It has lost nearly 5% in the past year as of Monday close.

“In the past couple of years, the market hasn’t gone anywhere. If you believe in the reversion to the mid-2014 levels, you’re likely to get much better returns than 4% a year over the next four to five years,” he said.

“You really have be confident that the index is going to continue to move sideways looking forward.

Brexit and credit

Foldes said he had other objections. The first one was the credit quality of British issuers since the U.K. vote on Friday to leave the European Union, known as “Brexit,” which put global markets under pressure and immediately caused banks’ credit default swap spreads to widen, especially in the U.K.

“British banks are under pressure. Looking at this from the view of Brexit creates some issues...eyebrows are raised. You definitely have to take into account credit risk exposure,” he said.

From Monday a week ago to Friday’s Brexit, HSBC’s CDS spreads widened from 91 basis points to 112 bps, according to Markit. On Monday, the spreads jumped to 119 bps.

In addition to credit risk, investors as it is the case with all structured notes had to forego dividends. In this case, investors are not collecting yield over a relatively long period of time, he noted.

“You’re giving up the S&P dividends over four and a half years. On a compounded basis, in the neighborhood of 9.5%, 10% is already gone,” he said.

“Finally you’re not getting any downside protection, and there are no dividends to give you that benefit.”

The upside risk could not be overlooked.

“If there is a reversion to the means, you don’t want to get capped out. Getting three times leverage is very nice, but you may easily get capped out and you’re giving up 9% in dividends.

“British banks with Brexit are more problematic today than they were on Thursday.

“I don’t think we’d have a lot of interest in it.”

Positioned for a downtrend

Andrew Valentine Pool, main trader at Regatta Research & Money Management, expressed concerns about the absence of any downside protection.

“As of Friday market close, we wouldn’t be purchasing this item,” he said.

“Although we think the U.S. is one of the strongest markets in the world, statistically we’re due for a market pullback.

“Having no downside protection is not a discussion we’d want to have with our clients if the market is down two, three or four years from now.

“Despite what’s happening today, the S&P remains very rich. We wouldn’t enter the S&P now on the highs we’re currently seeing.”

The vote by the U.K. on Friday has provoked a two-day selloff. The S&P 500 index, under pressure on Friday and Monday, lost more than 5% from Thursday close.

HSBC Securities (USA) Inc. is the underwriter.

The notes are expected to price on June 28.

The Cusip number is 40433UQB5.

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