HSBC's 7%-9% notes linked to S&P 500, Russell offer fixed income and possible early exit

By Emma Trincal

New York, Aug. 3 - HSBC USA Inc.'s 7% to 9% autocallable yield notes due Aug. 30, 2013 linked to the S&P 500 index and the Russell 2000 index can appeal to income-seeking investors willing to take some downside risk and open to the idea of an early redemption, said Suzi Hampson, structured products analyst at Future Value Consultants.

Interest is payable quarterly, according to an FWP filing with the Securities and Exchange Commission.

The notes will be called automatically at par plus accrued interest if the indexes close above their initial levels on any quarterly observation date.

A trigger event will occur if either index falls below the trigger level, 60% of the initial level, on any trading day.

If a trigger event does not occur or if it does occur and the return of the least-performing index is zero or positive, investors will receive par at maturity.

If a trigger event occurs and the return of the least-performing index is negative, investors will share in those losses.

"It's a reverse convertible product in essence because you get your coupon regardless of the underlying performance," Hampson said.

"In that way, it differs from an autocallable where you get paid only when the notes are called.

"This is callable too, so it's a hybrid between reverse convertible and autocallable. We call it [an] autocallable income product, but what it is really is a callable reverse convertible."

Good barrier

One particularity for this note, she added, is the "worst-of" payout. If the 60% closing-level barrier is breached any time and if at least one of the two reference assets finishes lower than the starting price, investors get exposed to the negative return of the worst-performing index.

"This feature allows the issuer to offer slightly better terms. If they had constructed this on one index only, for instance the S&P 500, they would not have been able to generate that type of coupon on a one-year with a 60% barrier," Hampson said.

"In order to get those terms, they had to introduce more than one underlying index."

Naturally, the two indexes add more risk to the structure, she noted.

First, it only takes one index to breach the barrier. Also, only the worst index will determine the final payout, not the average of the two.

However, a few factors in the design of the product are more appealing to investors, she said.

"The barrier is quite low, and it's only one year. Those two factors sort of cancel out the impact of the worst of," she said.

In addition, worst-of notes are less risky when the two indexes are highly correlated, which is the case with the S&P 500 and the Russell 2000, according to Hampson.

"This is a little bit more conservative than many reverse convertibles we see," she said.

Riskmap

The riskmap is Future Value Consultants' measure of the risk associated with a product. The higher the riskmap on a scale of zero to 10, the higher the risk of the product.

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

The notes have a riskmap of 2.60, compared with an average of 3.50 for similar products. "The risk associated with this product is quite low, and it's obviously because of the barrier," she said.

The credit risk is average. However, the market riskmap of 2.08 is much lower than that of similar structure types, which show a 3.01 average market riskmap, she said. "Again you have a quite deep barrier on a one-year period. It significantly reduces the overall market risk," she said.

Future Value Consultants calculates a return score that measures the risk-adjusted return. The score is calculated from five key assumptions: neutral assumption, high- and low-growth environments and high- and low-volatility environments. The firm calculates a risk-adjusted average return for each assumption. The return score is the best of these five returns.

In a neutral scenario, investors have a 90% probability of generating an annualized return comprised between 5% and 10% and a 10% risk of losing more than 15% of their principal.

Future Value Consultants runs its model based on a coupon within three-quarters of the announced coupon range. This product's coupon range is 7% to 9%, so the assumed coupon for the model is 8.5%.

"Based on this assumption, the product is giving you more than the average for the same product type," she said.

The return score for the notes is 6.54 versus an average of 6.28 for its peers.

"Again, if 8.5% is the final coupon they price it at, you're getting a pretty good return for the risk," she said.

"But it's hard to analyze a return score when the coupon range is as wide as 2%. If they priced it at 7%, you would see a substantial decrease in the return score."

The same uncertainty clouds the price score as well, she said. This score measures on a scale of zero to 10 the amount spent on the options less the fees, giving an estimate of the value offered to the investors.

The notes have a 7.66 price score against 6.89 for their peers.

Price, overall

The price score and return score are averaged to obtain the overall score of the product, which represents Future Value Consultants' opinion on the quality of a deal.

The product received a 7.10 overall score, which is above the 6.58 average score for the same types of notes.

"We will update those scores once the deal prices. We really don't know much about risk/return and value until they set the coupon. That's a bit of a problem we have for the U.S. In the U.K. the announced terms are always fixed," she said.

"But what we can say is that this is an income product for someone looking for a coupon above the risk-free rate on a short duration. You have to be prepared to lose your entire principal, but the risk is reduced by the 60% barrier. You also have to be willing to accept an early redemption. If you prefer not to, you might prefer a more straightforward reverse convertible where you know what your term is," she said.

The notes (Cusip: 4042K12H5) are expected to price Aug. 24 and settle Aug. 29.

HSBC Securities (USA) Inc. will be the agent.

© 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.