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

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.