HSBC’s five-year 95%-protected notes linked to Hang Seng China offer bullish, conservative bet

By Emma Trincal

New York, March 13 – HSBC USA Inc.’s 0% market-linked notes due March 31, 2020 tied to the Hang Seng China Enterprises index give bullish investors a chance to achieve “ a nice return” while preserving nearly the entirety of their capital in a down market, said Tim Vile, structured products analyst at Future Value Consultants.

The trade-off is giving up leverage and being willing to hold the notes for five years, he added.

The payout at maturity will be par plus any index gain, up to a maximum return of 50% to 55%. The exact cap will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

If the index falls, the payout will be par plus the index return, subject to a minimum return of 95% of par.

One-to-one

“This is a product that’s almost fully protected. You will not lose more than 5% of principal except if there is a default. You get one-for-one on the upside. In this case we used the mid-point cap of 52.5%,” Vile said.

Having no leverage enables the issuer to protect almost entirely the capital on the downside.

“You will be exposed to the first 5% losses, but after that there’s no more exposure to a market decline,” he noted.

“You have to rely on the index growth only for your returns. The leverage is not going to be there. That’s why the cap is so high. This is a 10.5% a year cap, or more specifically an 8.8% compounded return.”

While not as commonly used as the S&P 500 index or the Euro Stoxx 50 index, the Hang Seng index is “quite a well-known index,” he said.

“If you’re bullish and think the Hong Kong stock market is going to rise, this is a good way to achieve a decent return with protection.”

The investor profile is not clear-cut, he said.

“You are bullish enough to expect a good return on a one-to-one basis. At the same time, you are still very aware of the downside risk and seek some protection against it. I would say this is for the moderately bullish individual who needs the capital protection. A more bullish investor would give up some of the protection to achieve higher potential gains. They would for instance choose a 50% capital protection or a barrier in an effort to get rid of the cap or to raise it,” he said.

The Hang Seng is a “pretty choppy” equity market, he said.

“Prices have registered wide moves over the past five years. This is why one would want a deep level of protection. At the same time, the five-year maturity may help as it may provide enough time to give the index a chance to rebound after a decline or correction,” he said.

The note falls into Future Value Consultants’ “unleveraged return” category. It is rated against any similar note that offers 100% participation in the upside with or without a cap regardless of duration and downside exposure.

Market risk

Future Value Consultants assesses the risk associated with a product by adding two risk components: market risk and credit risk. The resulting riskmap measures risk on a scale of zero to 10 with 10 as the highest level of risk possible.

“The market risk is very low,” Vile noted.

“The notes have a 1.50 riskmap, compared with 2.99 for the average of the same product type. We know why: the investor can only lose 5%. That’s pretty minimal. We’re more used to seeing the opposite with buffered notes guaranteeing 5% or 10% of principal.”

The 0.90 credit riskmap on the other hand is higher than the 0.55 average for this type of note. Vile said that duration is the factor in this case.

“Most similar notes are under five year, so you’re rating this against shorter products. And the longer you hold the notes the greater the probability of a default,” he said.

Risk-adjusted return

Future Value Consultants measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions: neutral assumption, bull and bear markets and high- and low-volatility environments.

A risk-adjusted average return for each assumption set is then calculated. The return score is based on the best of the five scenarios. The bullish assumption is the one used for the rating in this case.

The return score (7.49) is more in line with the average (7.66), according to Future Value Consultants’ report.

“The higher credit risk elevates the overall risk score as measured by the riskmap, that’s one factor. The other factor is that the product is still capped. A lot of unleveraged notes are not capped, and so you’re competing with these structures, which will score better on the risk-adjusted return scale,” he said.

High price score

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10. This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

The product’s price score of 9.01 is significantly better than the average for the structure type, which is 7.27, according to the report.

“Two factors play in the favor of a strong price score in this case,” he said.

“First, it’s a longer-dated product, which allows the fees to be spread out over a longer period of time.

“The second factor is the capital protection. Those products tend to price better than any others in general.”

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. The score is the average of the price score and the return score.

The overall score is 8.25. It “compares well” with the overall for the average similar product of 7.47, he noted.

“This is a strong product if you think this index is going to go up. It offers the advantage of giving you a high level of protection as well. You get a bullish note with capital protection.”

HSBC Securities (USA) Inc. and UBS Financial Services Inc. are the agents.

The notes will price on March 27 and settle on March 31.

The Cusip number is 40433BH50.

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