HSBC’s step down trigger autocall tied to three indexes adds defensive feature to worst-of

By Emma Trincal

New York, Aug. 25 – HSBC USA Inc.’s 0% step down trigger autocallable notes due Aug. 30, 2019 linked to the least performing of the Euro Stoxx 50 index, the Russell 2000 index and the S&P 500 index show an intriguing mix of features, one of which increases the chances of earning a positive return and the other leading to potentially high losses, said Suzi Hampson, structured products analyst at Future Value Consultants.

The notes will be automatically called at par of $10 plus 8.9% if each index closes at or above its initial level on Aug. 27, 2018 or at par plus 17.8% if each index closes at or above its downside threshold, 75% of its initial level, on Aug. 26, 2019, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not subject to an automatic call, then the final level of at least one index will be less than its downside threshold, and investors will be exposed to the decline of the least-performing index from its initial level.

The structure differs from most autocalls because the call trigger decreases instead of being at a constant level, Hampson said.

“The step down is the selling point. It increases the odds of getting called since the second call is below the initial price. The final call level is the same as a European barrier. But instead of having a point-to-point payoff, you get this autocall in the middle.”

Either win or lose

Such structure contributes to simplify the return outcomes.

“There is no chance of just getting your money back,” she said.

“You either make money or lose money. Either you get the call premium on the first call or at the end as the maximum return, which is double the coupon or you breach the barrier and lose at least 25% of your principal.”

This type of product called “defensive autocall” is very common in the United Kingdom, she said.

“We have a lot of them. They’re usually longer and the trigger declines progressively in shorter intervals,” she said.

In the United States, however, such a structure is much less common, she noted.

This particular note was different not just from the typical U.S. autocallable but also from its European counterparts.

“It’s a two year with two call points. You don’t usually see only two call dates. It’s more like quarterly or semiannually observations,” she said.

Future Value Consultants runs stress test reports on structured products. Each report comprises 29 different tables, which its clients can choose from. In order to analyze the probabilities of return outcomes under various market scenarios, Hampson used some of the tables, which are included in the report.

Positive return likely

The notes offer a relatively high probability of generating a positive return.

“This doesn’t mean there is no risk as we will see from the probabilities of loss of capital and average losses,” she said.

She first looked at the capital performance tests. This table shows the probability of three outcomes: return more than capital, return exactly capital, return less than capital.

The results are simulated based on several market scenarios. In the neutral one, which is consistent with pricing, the growth rate derives from the risk-free rate minus the dividend applied to the asset.

On this base-case scenario as mentioned before, the probability of receiving at maturity the exact amount of initially invested capital is zero.

The chance of getting “more than capital” is 75.92%. This positive outcome is only achieved in two cases: call on the first call date with the 8.9% premium, which happens 36.17% of the time; if not, second “call” at maturity with the maximum return, this second possibility representing a 39.75% probability.

The step down trigger leads to the reverse probabilities as what is commonly seen with autocallables, she said.

“Normally when the trigger is at initial price you’re much more likely to kick out on the first call. But because this one has a lower threshold on the second call point, it’s more likely to happen then,” she said.

“It increases the chances of the call happening at maturity,” she said.

“You have a 36% chance of a call after one year at 8.9%. But it’s really the call at point two that shows the highest probability of 39%.”

It does not mean that the odds of losing are small, she noted. Those represent a 24.08% probability in the neutral scenario.

“You have a high probability of getting a decent return. But a 25% chance of loss isn’t small. Investors need to take into account the fact that they’re investing in a worst-of with three indices,” she noted.

“If this was done on a single underlying, the 25% barrier or its equivalent at maturity would be pretty defensive. But it’s not the case. So there’s obviously risk in this product.”

The “risk” however offered an interesting balance. On the one hand the lower threshold at maturity increased the chances of generating a positive return. It also eliminated the possibility of receiving just par. But the worst-of payout made losses more likely as well as more substantial.

Another table called the scorecard shed some light on the average loss as percentage of principal.

The investor scorecard is made up of a number of different mutually exclusive outcomes of product performance. It shows outcome names, probability of occurrence, average return and average duration.

If the worst index finishes below the 75% threshold, the average loss will be 41.7%, according to the scorecard.

Future Value Consultants for its simulation uses four other market scenarios in addition to the neutral, which reflect their own growth assumption. Those are: bull, bear, less volatile and more volatile.

In the bear scenario the average loss rises to 45.5% and happens 38.39% of the time. The bull scenario on the other hand shows a lower loss of principal of 37.9%, which only occurs 12.75% of the time.

Future Value Consultants offers backtested results for its clients who want to know about historical performance. Those tables come in three time horizons: the last five, 10 and 15 years.

When looking back, the chances of a call occurring on the first call date are much higher than what the simulation anticipates.

“We’ve been in a bull market for many years now,” she said.

Instead of a 36% probability shown in the scorecard, the call on point one happened 62.45% of the time in the last five years, 56.61% of the time in the last 10 and 57.08% in the past 15 years.

“This shows that historically the probabilities of calling at point one are much higher,” she said.

“There is still a great chance of being called at point two, a much greater chance than if the call was at 100.

The “call at point two” probability is 37.55% over the past five years. It drops to 28.71% and 24.16% for the last 10 years and 15 years, respectively, according to the report.

To conclude, Hampson pointed to the complex nature of risk in the product.

“Having a lower call threshold definitely adds value. It’s the defensive aspect of this note,” she said.

“Does it mean this is designed for conservative, risk-averse investors? I wouldn’t say that.

“Yes, the autocall level, the low barrier are defensive aspects of the product.

“But it’s linked to three different underlying, so if one of the three really goes bad you start to lose a lot of money.

“This product is simply geared toward investors who think volatility will remain limited in global markets over the next couple of years.”

HSBC Securities (USA) Inc. is the underwriter with UBS Financial Services Inc. acting as agent.

The notes will settle Aug. 31.

The Cusip number is 40435G519.

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