HSBC's 10.5% callable yield notes on Russell, Market Vectors Gold seen as hard to analyze

By Emma Trincal

New York, Feb. 16 - HSBC USA Inc.'s upcoming 10.5% callable yield notes due Feb. 27, 2012 linked to the Russell 2000 index and the Market Vectors Gold Miners exchange-traded fund are seen as complex and difficult to analyze given the "worst-of" payout and the two underlying components, financial advisers said.

The notes pay interest quarterly, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par unless either underlying component closes at or below the to-be-set trigger level - 60% to 65% of its initial level - during the life of the notes, in which case investors will receive par plus the return of the worst-performing underlying component, subject to a maximum payout of par.

The notes will be callable at par on any interest payment date.

Mixed metrics

"I don't like the structure, and I don't like the two underlyings," a financial adviser said.

"Each time you have a pair or even a basket of securities as your underlying, it makes the investment decision too complicated. I'm not a big fan of those mixed metrics."

Pick your loser

This adviser said that between the Russell 2000 and the Market Vectors Gold Miners ETF, the most likely to incur a sharp drop of 40% or more would be the gold stock ETF.

"If it was just the Russell, I wouldn't be concerned because I don't see this benchmark over the course of one year being down 40%. No way," he said.

"Gold on the other hand, gold-producing companies, these things are all over the place. They're trading at all-time highs."

For this financial adviser, the two underlyings move in opposite directions, which makes the product even more risky because it makes it more probable that the barrier will be breached on the downside.

"Investors bullish on equities are likely to be bearish on gold and vice versa," he reasoned. Because he anticipated the Market Vectors Gold ETF to be the worst performer of the two, he concluded that the notes would be a better fit for gold bulls rather than equity bulls.

"It's really a bearish note on the market, but you're betting that the Russell is unlikely to fall below 40%," he said.

The financial adviser said that he held the opposite view, which is why he would not consider the notes.

"I'm more bullish on the market, and I see the risk with gold," he said.

Bullish on both

Michael Kalscheur at Castle Wealth Advisors agreed that the structure was complex.

"Having the two underlyings complicates the analysis a little bit. You have to run your analysis based on what you think will be the worst of those two. It's a little complicated - not impossible, but more complicated," he said.

At first glance, Kalscheur said that the structure was too risky.

"It violates one of our fundamental rules, which is to reduce or not take on additional risk. I'd rather have a capped upside with some downside protection," he said.

But looking at the coupon, he noted, "You do get this 10.5% coupon, no matter what, which is a form of downside protection."

The question is whether 10.5% is sufficient given the two underlyings and the payout structure based on the worst performer of the two.

"I would have to do more research on the Market Vectors Gold. One good thing is that it's an ETF, so you have some diversified exposure to gold stocks," he said.

"But something happens, commodities take a big hit, and there's obviously some additional risk. I would take a wary eye on it."

Kalscheur said that an investor buying the notes would have to be bullish on both stocks and gold.

"Between the Russell and the Gold Vector, it's the ETF that's the most volatile. If you don't see gold stocks dropping by more than 40%, then you could consider it.

"If you're bullish on the market and bullish on the gold stocks, I can see the benefit. I really like the 10.5% coupon."

Kalscheur said that investors need not be very bullish on equity and gold, but simply "mildly bullish."

"You could just be happy that things stay the same. If you're right, you'll make a lot of money.

"You're almost betting on volatility. You're betting that there won't be a full shock," he said.

The notes (Cusip: 4042K1DZ31) are expected to price Feb. 22 and settle Feb. 25.

HSBC Securities (USA) Inc. is the agent.

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