HSBC’s $8.35 million autocall trigger PLUS on S&P to offer income or growth opportunity

By Emma Trincal

New York, June 21 – HSBC USA Inc.’s $8.35 million of 0% autocallable trigger Performance Leveraged Upside Securities due June 21, 2024 linked to the S&P 500 index may give investors a sizable one-year coupon or uncapped leveraged participation in the index depending on the price of the index after one year. While advisers do not know in advance the exact nature of their potential payoff, they said they were comfortable with both outcomes.

The notes will be called at par plus a premium of 13.4% if the index closes at or above its initial level on June 22, 2023, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called and the index finishes positive, the payout at maturity will be par plus 1.25 times the index gain.

If the index finishes negative but at or above the 75% trigger level, investors will receive par.

Otherwise, investors will lose 1% for each 1% decline of the index from its initial level.

Fee, creditworthiness

“For the most part this is an attractive note,” said Steven Foldes, wealth manager and founder of Evensky & Katz / Foldes Financial Wealth Management.

“Some things bother me though, like the 2.5% fee, which is quite high for a two-year note.

“But I do like the credit. HSBC is a solid issuer.”

The five-year credit default swap rates for HSBC are 95 basis points, according to Markit, versus 128 bps for Goldman Sachs, 120 bps for Citigroup and 117 bps for Morgan Stanley.

Income play

Foldes first focused on the call premium.

“Getting 13.4% after one year by the simple virtue of being flat or positive from where we are today seems like a very nice income play. Even if we have slightly higher rates a year from now, this coupon is really compelling,” he said.

Since the S&P 500 index is in bear market territory, the odds of a positive return at maturity if the notes do not get called are reasonably high, he noted.

“We’re already down 21% this year. If the notes mature, you’re looking at 1.25x the upside without a cap, which is also attractive.

“You get the coupon or if there’s no call, you get the leverage and the uncapped return. These are very nice terms,” he said.

Buffer versus barrier

Regarding the downside, Foldes said he would want to know if switching from a barrier to a buffer would be beneficial.

“I’m not saying I would switch to a buffer, but I would want to price out a buffer. What type of a hard buffer would I get for giving up the 75% barrier?”

Overall, Foldes said he liked the notes.

“It’s a creative product. In one note, you get either the income or the uncapped leverage.

“The first leg of this trade, the 13.4% digital coupon, is a pure income play. You don’t participate in the upside. But it’s a very nice coupon.

“The second one gives you unlimited leveraged upside, which is a pure growth play.

“So, the structure is creative in that it gives you two different opportunities to outperform. This is what makes it interesting,” he said.

Tough analysis

A financial adviser said he liked the notes but wished he could test the various outcomes more easily.

“I’ve seen this type of note before. It’s an exciting one but also a frustrating one because I run my risk analysis using back-testing data. For this particular note, I can’t really break out what the chances of return are on year two after a negative return on year one,” he said.

He compared this challenge to the one he has to face when assessing worst-of notes.

“With a worst-of, you don’t know in advance what your exposure is going to be. Here, you don’t really know if you’re dealing with a one- or a two-year note.”

Likely call

Nonetheless this adviser decided to run an analysis of possible outcomes based on back-testing data on the S&P 500 index over the past 70 years.

He found that the S&P 500 index over a one-year period had a 26.1% chance of being negative.

“You’re looking at a 74% chance of getting called out after one year. This gives you automatically a 13.4% return, which isn’t too bad.

“In fact, if you quibble at a 13.4% annual return, you’re just being greedy,” he said.

The tables also showed a 34.6% chance of a positive return below the 13.4% call premium over a one-year rolling period. Such scenario would represent the situation in which the notes outperform the market.

The other outcome – the one in which investors are “capped out” and underperform the index, was seen with a 39.3% frequency.

“These odds are decent if you consider all outcomes, including the negative ones. However, if you look at the positive outcomes only, it’s not as good since you don’t even have a 50/50 chance of beating the market,” he said.

Downside risk

A reliable analysis of potential positive returns would require having two-year timeframes characterized by a decline in the first year followed by a recovery in the second year.

“I only have the frequency of a negative return over a two-year period, point-to-point. And that is 18% of the time,” he said.

“But we could have enormous black swans in this market. You could see 25%, 30% or 35% drawdowns.”

Another reason to be cautious was the two-year tenor itself. For instance, the most likely timeframe for a 30% market drop is a 27-month period, he said.

“That’s close enough to 24 months; so, in theory it should be a concern. But it happens only 3.4% of the time, which is not a big chance,” he said.

Overall, the analysis indicated that investors had a “decent chance” to outperform on the downside.

Using the same set of data on the S&P 500 index, this adviser noted that a decline of more than 25% has happened only 4.2% of the time.

“This is a great result. Not a big chance to breach the barrier. And compared to the 18% chance of a negative return, this barrier is doing its job, protecting you three-quarters of the time,” he said.

While the risk analysis was complicated by the uncertainty around the autocall event, this adviser said the chances to outperform the market, including on the downside, were satisfactory.

“The barrier is wide enough to give me confidence. This is certainly an offering I would consider,” he said.

HSBC Securities (USA) Inc. is the agent. Morgan Stanley Wealth Management is acting as distributor.

The notes settled on Tuesday.

The Cusip number is 40439N726.

The fee is 2.5%.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.