HSBC's buffered AMPS linked to iShares FTSE/Xinhua China 25 ETF fit slower growth outlook

By Emma Trincal

New York, March 2 - HSBC USA Inc.'s 0% buffered Accelerated Market Participation Securities due Aug. 28, 2013 linked to the iShares FTSE/Xinhua China 25 index fund may appeal to investors expecting more growth in the Chinese equity market but not that much and seeking some downside protection should a correction occur, said structured products analyst Suzi Hampson at Future Value Consultants.

The payout at maturity will be par plus double any fund gain, up to a maximum return of 20% to 23.5%. The exact cap will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the fund's share price falls by up to 10% and will be exposed to any decline beyond 10%.

A 20% to 23.5% cap on 18 months is the equivalent of 13.33% to 15.66% per annum, Hampson noted, which is "a decent return."

In addition, the underlying exchange-traded fund needs only to grow by half of that given the leverage factor of two, she noted.

Therefore, with only 6.66% to 7.83% of annual growth in the fund, investors can maximize their upside, she said.

Mildly bullish

"Geared products like this one should be appealing to investors who don't foresee a lot of growth," she said.

"They see that the ETF has performed well, and so they think maybe it's not going to keep going up at that speed forever."

The iShares FTSE/Xinhua China 25 index fund give exposure to 25 of the largest and most liquid Chinese companies that publicly trade on the Stock Exchange of Hong Kong Ltd. and are available to international investors, as measured by the FTSE/Xinhua China 25 index.

The fund is up by 15.5% year to date. It has lost 5.5% over the past 12 months.

"The underlying has been growing so much lately, investors may want to pick up some additional growth while still protecting the downside," she said.

If the fund grew by more than 10% to 11.75% over the term, investors would start to underperform a direct position in the ETF, she said.

On the downside, however, investors are going to outperform the fund in all cases because they have the protection from the first 10% losses.

"They still have to sacrifice the dividends," she said.

"But in spite of that, the buffer still gives them the opportunity to do better on the downside than a long position in the fund.

"So this offers a decent risk/return profile. You have the potential of getting 13% to 15% a year with this product, twice more than in the fund because of the gearing. And you're limiting your downside exposure. If you're happy with the cap, it's a decent trade-off.

"Obviously, if you're really bullish, you wouldn't want the cap so you wouldn't consider buying this note. This is for someone who expects the fund to grow only moderately over the 18-month period."

Lower risk

The buffer is the risk-reducing factor in this structure, she said, even if the 28% implied volatility for this ETF is higher than that of the S&P 500's current 21% level, she said.

Future Value Consultants rates the risk associated with a product on a scale from zero to 10 with its riskmap.

For this product, the riskmap is 3.61 versus the 4.84 average riskmap for other products of the same structure type - namely, leveraged notes with or without downside protection and with various maturities.

Compared to all products recently rated by Future Value Consultants, which include a large quantity of reverse convertibles and whose average riskmap is 4.69, this note is also less risky based on its score, she noted.

The riskmap is the sum of two risk components: market risk and credit risk.

For this product, the credit risk of 0.81 is less than 0.86, the average score for the same type of products.

However, the credit riskmap is slightly higher than that of all products, mainly because of the notes' duration, said Hampson, noting that most of the reverse convertibles that populate the broader category have a three-month or six-month tenor.

On the other hand, the 2.81 market riskmap is lower than the market riskmap for all products (4.03). It is also less elevated than the 3.98 market riskmap for similar leveraged types of structures.

"Overall, the riskmap is low, and that's because of the buffer," said Hampson.

"Even though the underlying is more volatile than the S&P 500, it's still less risky than all products because you compare it to reverse convertibles that have barriers in the place of buffers or you compare it to some other products that offer no downside protection at all."

Risk/return profile

Future Value Consultants measures the risk-adjusted return with its return score. A high return score means that the return compared to the risk is high.

Established on a scale of zero to 10, the return score is calculated under reasonable and consistent forward-looking assumptions. The firm uses five key assumptions: neutral assumption, high- and low-growth environments and high- and low-volatility environments. The return score is based on the best of the five scenarios.

In this case, the best market assumption would be high growth. Future Value Consultants' methodology has set a "non unrealistic" level of high growth in its methodology, capping it at 7% per year.

The product received a 7.19 return score. The rating is in line with the average for the same category, 7.07, and is higher than the 6.43 return score applying to all products.

Based on the cash return assumption, there is a 50% chance of this product generating a 5% to 15% annualized return. The chances of losing versus making money are one-third and two-thirds, respectively.

The highest probability falls into the 10% to 15% positive return per annum with a 46% probability, according to the chart.

"This is quite a happy medium. You limit your upside, but you have a pretty decent cap with decent probabilities of hitting the cap," Hampson said.

When switching to the high-growth assumption, which is the optimal one on the basis of which the return score is calculated, the probability chart becomes more attractive to investors.

Noteholders have a 59% chance of getting a 15% or more annualized return and a 10.2% probability of losing more than 15%.

With this market assumption, there is an 80% probability for a positive outcome against a 20% probability of losses.

Value and overall

The notes also provide value to investors, said Hampson. Value is measured by the price score, Future Value Consultants' estimate of the total costs taken out of the product from direct fees and profit margin on the underlying derivative.

For these notes, the price score is 8.16. The average is 7.29 for the same product type.

"This could simply be because there are a lot of products out there in the accelerated growth category, so pricing is probably tighter. They want to make the terms as good as possible," said Hampson.

Future Value Consultants offers its opinion on the quality of a deal with its overall score, the average of the price score and the return score.

The notes have a 7.68 overall score, which is better than 6.68, the average overall score for all products.

"It scored above the average of all products for all ratings and it has a below-average risk, so the overall score is high on the chart," she said.

HSBC Securities (USA) Inc. is the agent.

The notes will price on March 9 and settle on March 16.

The Cusip number is 4042K1YB3.

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