HSBC USA is Offering an Interesting Structured Product, but 5 Year CDs are Better

HSBC USA is Offering an Interesting Structured Product, but 5 Year CDs are Better

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HSBC USA, HSBC’s US subsidiary, is currently syndicating a 5-year structured note that is offering 2.25% for the first two years, followed by the 3 month LIBOR rate, plus 1.05% for the following three years.  Payment is capped at 4%.

I have been a fan of structured notes for some time.  I have found that some of the structures enable you to pick up strong yield with negligible risk.  The notes that I like the most involve 2-30 spread structures and ordinarily pay a multiple of that spread, calculated quarterly.   These structures can yield 5 to 10% in consideration for tying your money up for between 10 and 20 years, and assuming the credit risk of the issuing bank (such as Citibank, JP Morgan and Morgan Stanley).

The HSBC USA note, however, does not offer the prospect of particularly high returns.  In fact, it may earn less than a 5-year CD over its 5 year life, as short term rates would need to continue to move up from here for the note to earn anywhere near 2% in years 3, 4 and 5 (3 month LIBOR is currently only 64 bps).   By contrast, the best nationally offered 5 year CD rate is 2.15% and rates may be higher in local banks where you live (see the best national and local rates here).

A 5-year CD is going to be FDIC or NCUA insured so long as you stay within FDIC insurance limits (usually $250,000).  The HSBC note involves credit risk, and while HSBC USA is currently rated Single A, the parent bank could face increasing scrutiny worldwide as the Panama papers seem to demonstrate that its main line of business is facilitating questionable tax avoidance schemes.  

To boot, a 5-year CD is ordinary going to have some liquidity.  You can ordinarily pay an early withdrawal fee and get your money back if rates move against your position or if you need the money.   See our recent article about early withdrawal fees here.  Barclays and Synchrony both have early withdrawal fees equal to only six months of the CDs interest on their 5-year CDs.   This structured note, by contrast, is completely illiquid.

Finally, while both the CD and the structured note are going to be treated as ordinary income for tax purposes, the structured note can often hit you with something called original issue discount (OID) which will be treated for tax purposes as ordinary income.  After you factor in the OID when preparing your taxes, you can often find that the effective return on a structured note is a lot less than you believed you were getting. 

Bottom line: Structured notes can be an important part of any portfolio designed to generate yield, but you need the right structures.  If the note doesn't offer a return that is commensurate with the risk, CDs will provide far more sensible ways to accomplish your goals.

See the best 5-year CD rates here.

This note is CUSIP 40433ULE4 and ISIN US40433ULE46.  As with any structured note, you will need a brokerage account at a place like Morgan Stanley or BAC Merrill in order to get in.  


Can You Always Withdraw Your Money Early From a CD?

Can You Always Withdraw Your Money Early From a CD?

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The short answer: no.

By buying certificates of deposit (CDs), depositors can easily pick up an increase in yield over savings rates in exchange for agreeing not to have access to their money for a period of time.  When rates are going down or staying constant, CDs can also protect from falling savings rates.

When savings rates are increasing quickly or where depositors need access to their money for another investment or an unforeseen expense, having money locked into a CD can be troubling.  Virtually every CD has terms and conditions that allow the depositor to get money back by paying a fee, expressed as an amount of interest the CD pays, for early termination.  BestCashCow has always found that a fair penalty for early termination of a CD of less than 1 year is 3 months of interest, for those CD between 18 months and 5 years is 6 months of interest.   Early termination fees can affect principal if CDs are terminated just after opening, and are always waived in the event of death or adjudged incompetence of the holder.

A deeper look at most terms and conditions can expose two risks to relying on early termination fees.  First, the bank or credit union sometimes retains an express right to refuse an early withdrawal (we note that AIG, Bank of America, US Bank, and USAA Bank are among those larger banks that have provisions in CD terms and conditions limiting early withdrawals to those where the bank consents).  Second, even if the terms and conditions do not require the bank or credit union’s consent, terms ordinarily include provisions that allow the bank to make adjustments, which may allow them to require their consent in the future or to increase the early withdrawal penalty and apply those changes retroactively to existing CD holders.

BestCashCow has always taken the position that depositors should carefully read the terms and conditions of any product that they purchase.  While some other financial websites recommend planning around early termination fees, we also recommend that depositors not engage in creative financial planning around paying fees, but rather only purchase CDs that they plan to hold to maturity.  For this reason, and against the backdrop of possible rising rates (but the equally great likelihood that we are following the Japanese paradigm), we recently recommended that depositors will now find their best opportunities and safest bets in 1-year CDs.

Federal law provides some protections from changes in terms and conditions affecting early termination of CDs.  Pursuant to Regulation DD, a bank or credit union is required to provide 30 days written notice of a material change in the terms of a CD.   The addition of a provision requiring consent to early termination or a change in the terms of an early withdrawal penalty would be considered a material change.  The recourse for a depositor however is limited.  They may act within the 30 days and contact the financial institution to opt out.  If the institution does not permit opting out, they may terminate the CD according to the existing penalties.   When a credit union changed its early termination fees in 2011, the National Credit Union Administration (NCUA) took the position that its own rules were not violated and that federal consumer protection law provides no additional protection above that provided by Regulation DD.    Presumably, the FDIC would take the same position for banks.

State consumer protection laws and common law related to contracts may also provide some protections from changes.  Some attorneys suggest that the terms and conditions are a contract of adhesion and therefore the right to make changes to these terms, even if retained, cannot be done easily, especially when the purchaser has no ability to opt out.   From my own studies, I think that the contract of adhesion argument is unlikely to hold up in a court of law.   There is a large marketplace with many sellers of CDs and the buyer of a financial instrument is assumed to have a certain degree of sophistication regarding the risks (and therefore is treated differently from buyer of a ticket to a baseball game or an amusement park).

As a CD purchaser or CD holder, you do not want to litigate issues related to early termination fees.  You just want to mitigate your risks of a bank or credit union refusing an early withdrawal or changing the withdrawal penalty amounts.  You can do this through a careful understanding of the terms and conditions and purchasing shorter term CDs.  Buying CDs only from well-known and highly visible institutions (such as Barclays, Synchrony, Sallie Mae Bank or GS Bank) can also serve as a form of protection.  Any of these banks will likely be more apprehensive about changing the terms of a CD or refusing an early withdrawal all together, as they will face significant backlash throughout social media and on sites like BestCashCow.  A smaller bank or credit union might be less concerned. 

Find the best CD rates here.


ELoan CD Early Withdrawal Penalties are Too Onerous, Not Market

ELoan CD Early Withdrawal Penalties are Too Onerous, Not Market

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As interest rates (and the stock market) appear to be headed down over the last few weeks, there has been renewed interest in longer term CDs as a place to hide out, preserve cash, gain yield. ELoan's rates are among the highest on BestCashCow.com's CD tables, but the onerous early withdrawal penalties mean they might not be the best place to put your money.

ELoan, which is now owned by Banco Popular, currently has some of the best online CD rates just about all maturities on the BestCashCow.com CD tables.  While the recent rise in ELoan's rates might be somewhat driven by Puerto Rico's credit problems, the CDs are issued by Banco Popular's NY branch and are fully FDIC insured (as long as you stay within FDIC limits).  However, if you look at the terms on ELoan’s website, you’ll see that the penalties for early termination are extraordinarily onerous.  ELoan charges 2 years of interest as a penalty for early termination of a 5 year CD, 1 year on the 3 and 4 year CDs, and 9 months on the 1 year CD.   If you were to put $200,000 in a 5 year CD with ELoan and then either need the money or see much higher rates, you would be paying almost $5,000 in penalties to become liquid.  Given the likelihood of dramatically higher interest rates, it would be foolhardy to tie your money up in a CD with such dramatic early termination penalties.

ELoan’s penalties are completely out of line with those of ELoan’s competitors.  Albeit with slightly lower rates, Sallie Mae’s 1 year CD has a 3 month early termination penalty.  Barclays Bank and Synchrony Bank offer online 5 year CDs carrying only a 6 month penalty (learn more about strategies involving these rates here).    CIT Bank offers a 5 year CD with a 1 year early termination fee, and has very 1, 2, 3 and 4 year Ramp Up CDs that allow you to get a higher rate if interest rates rise (CIT’s Ramp Up CDs were named a BestCashCow.com Best Bet for 2015).  

Given the likelihood of dramatically higher interest rates in the intermediate term - if not the near term -  we feel that depositors would be much better served to look at these products and to avoid ELoan onerous early termination fees.

See and compare all of the best CD rates, online and available locally, here.

See all of the best CD rates here.  

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