HSBC's notes with coupon linked to yuan offer principal protection with relatively short tenor

By Emma Trincal

New York, May 9 - HSBC USA Inc.'s currency appreciation coupon securities due May 31, 2016 linked to the Chinese renminbi relative to the dollar offer an unusually short tenor for a principal-protected note, sources said.

"Five years is definitely shorter than other principal protection [notes] that have come across my desk recently," said Michael Kalscheur, financial adviser at Castle Wealth Advisors.

The securities will pay conditional annual coupon payments of 4.5% to 5% if the spot rate is less than the trigger rate on the coupon observation date, according to an FWP filing with the Securities and Exchange Commission.

Appreciation in the renminbi relative to the dollar will cause the spot rate to fall.

The trigger rate is 98% of the initial rate on May 25, 2012, 96% of the initial rate on May 28, 2013, 94% of the initial rate on May 27, 2014, 92% of the initial rate on May 26, 2015 and 90% of the initial rate on May 25, 2016.

The payout at maturity will be par plus, if any, the final conditional coupon.

"I like it for the conservative investor," said Carl Kunhardt, director of investment management and research at Quest Capital Management. "And the five-year term is especially attractive. Most principal-protected notes now are seven or eight years."

Kalscheur agreed.

"It's very hard today to find a principal-protected note that's not a six or seven year. I wouldn't say that five years is short term, but [compared] to other products of this type, it's relatively short," he said.

Macro play

Kunhardt said he liked the bet behind the product and that the notes give investors who believe in the appreciation of the Chinese currency against the dollar a chance to get above-average returns.

"It's an attractive coupon, and the underlying premise I think is a no brainer," said Kunhardt.

"So long as we'll continue to have this monetary policy, the dollar will continue to depreciate against the Chinese currency."

He said that the Chinese are likely to keep a tight monetary policy in order to tame their inflation, which would support the rise of their currency against the dollar.

Fixed-income allocation

For Kalscheur, the structure offered the greatest appeal.

"The principal protection is by far the most appealing aspect of this product," said Kalscheur.

Even though the coupon is not guaranteed, the notes, in his view, belong to a fixed-income allocation because investors cannot earn more than the conditional coupon, if any.

"While the most appropriate place for this is a currency bucket, I would use it in a fixed-income allocation. The structure guarantees no downside other than a lost opportunity if the conditions are not met or a fixed coupon if things get into play," he said.

Kalscheur also said that he liked the digital coupon structure rather than a payout structure giving investors participation in the growth of the underlying.

"If the renminbi goes up 10% over the five years, I could make in theory 22%. It's pretty good overall, and you're not utilizing leverage," he said.

Risk/reward

Kalscheur said that the main risk for investors is that they could receive no coupon.

The prospectus specified in its risk section that even if the Chinese renminbi appreciates against the dollar, investors may not get paid if the spot rate on the observation date is greater than or equal to the applicable trigger rate.

"It is a conditional payment, and there is an opportunity cost," Kalscheur said.

"But at the same time, I like that you know today what the trigger rates are. It's based on 2% a year. It's pretty straightforward."

Kalscheur said that the attractive coupon offsets the uncertainty about the interest payment. "It's not a guaranteed rate. But are you getting out there CDs for five years that pay anywhere close to 5%?"

Interest-rate risk

Another advantage according to Kalscheur is that the notes expose investors to less interest-rate risk than other fixed-income securities such as corporate bonds or Treasuries.

"These notes depend on the appreciation of the renminbi versus the dollar. It's not directly interest-rates sensitive. It's not going to be as interest-rate sensitive [as] a five-year Treasury for instance," he said.

As a financial adviser seeking to reduce risk for his investors, Kalscheur said that he also liked the creditworthiness of the issuer. "It's a AA-, and it's pretty good relative to many others. It passed that hurdle," he said.

Finally, Kalscheur said that the structure offered the advantage of simplicity.

"Can I explain it to people? Yes. It's very straightforward. It's a currency versus another," he said.

The securities (Cusip: 4042K1HE6) will price on May 25 and settle on May 31.

HSBC Securities (USA) Inc. is the agent.

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