HSBC aims at mildly bullish investors with trigger autocallables linked to Euro Stoxx 50 index

By Emma Trincal

New York, March 7 - HSBC USA Inc.'s 0% trigger autocallable optimization securities due March 13, 2019 linked to the Euro Stoxx 50 index offer a reasonable return potential for investors who are not very bullish on European equity markets, said Tim Mortimer, managing director at Future Value Consultants.

The five-year tenor does not necessarily mean that the product has a long duration, he explained. The autocall feature is likely to trigger a payment and reduce the actual duration of the notes.

Beginning a year after issuance, the notes will be automatically called at par of $10 plus a call return of 8% per year if the index closes at or above the initial index level on any quarterly observation date, according to an FWP filing with the Securities and Exchange Commission.

The notes target investors who are mildly bullish on the Euro Stoxx, he said.

"It's an income product. You don't need any kind of return in order to make your 8% payout. The index only has to grow or stay the same. It just can't decline. So in that way, it is a bullish product but one that's very mildly bullish," he said.

"It's a structure geared toward someone who wants a reasonable return, not necessarily making a big bullish bet on the market, and that way, it's pretty easy."

If the notes are not called and the index finishes at or above the trigger level, 67.5% to 72.5% of the initial level, the payout at maturity will be par. Otherwise, investors will be exposed to the index's decline from its initial price.

Not a phoenix

The autocallable notes are standard in their structure and distinct from a variation of the product branded by UBS as "phoenix" autocallables.

In the phoenix product, which the firm categorizes as a reverse convertible, the coupon payment and the autocall can be triggered at different strikes and the coupon may be paid even in the absence of a call.

"This is not a phoenix," he said.

"In a phoenix, your call condition, at 100% of the initial price or more, is the same, but in addition you can make the coupon at a lower level without being called. Because the coupon is not guaranteed with the call, the phoenix structure tends to pay a higher coupon. The advantage of the phoenix is not only that you get a higher coupon but that you earn it during the life of the notes. With this product, you only get paid when the product terminates."

Both this type of autocall and the phoenix type offer "pros and cons," he said.

"This one is simpler. You don't get an extra barrier. The trigger for the autocall and the coupon barrier level are the same," he said.

One year of protection

The structure based on quarterly call observation dates offers one year of call protection, which guarantees that investors will get the full 8% return upon the first autocall, he explained.

The first observation date is March 12, 2015, according to the prospectus.

"You have the first call date after one year and then every three months. You get rising payments of 8% a year, so the longer you remain invested in the notes the more your return increases. Then you have a final, or European, barrier of about 70%," he said.

Very often with quarterly observation dates, investors get called on the first call date, which is only three months after settlement and would reduce the dollar amount of the return.

"You don't want your first call too early. If the first call was set on the first quarter - as it is mostly the case with those products - you'd get a 2% return. You would have gone through that effort just for 2%. Personally, I wouldn't invest in a product where you can be called after three months. But that's the risk you take with most quarterly observation notes. This one solves this problem. It's a little bit more logical," he said.

"In the U.K., we often see autocalls with annual observation dates and a no-call protection for the first year. So you actually get the guarantee that you're not going to be called in the first two years. This one does the same thing on a shorter scale. It's much better for the investor."

While the five-year maturity appears to constitute a relatively long-term investment for a structured product, there is a line to draw between maturity and the actual duration when it comes to autocallable notes, he said.

"Five years is quite long. We've seen that HSBC tend[s] to show longer products; they've done a lot of five-year [notes]. But it's important to remember that with autocalls, the maturity and the duration are not the same," he said.

Future Value Consultants uses the term "duration" to indicate the average expected life of the product, he explained, adding that for autocalls, the duration is likely to be less than the maturity. Based on Future Value Consultants' research, this product may have a life comprised between two-and-a-half years and three years.

"You know you have a 60% chance of getting called after the first year. Historically it's about 50/50. So you should not expect a fixed duration for this product. Five years is unlikely to be the time you're invested in the notes. You should expect to be kicked out fairly soon," he said.

Market risk

The notes have a certain level of market risk, which is due to the potential amount of losses in case of the breach of the barrier at maturity.

The market risk is one of the two components of the riskmap, Future Value Consultants' score for the overall level of risk of any given product, with 10 as the highest level of risk possible.

The other component is credit risk, which is measured by the credit riskmap.

The market riskmap for these notes is 3.35 versus an average of 3.17 for products of the same type, according to Future Value Consultants' report.

"It's pretty much in line with the rest of the group," he said.

The final barrier of about 70% and the volatility of the underlying employed are not the only factors driving market risk, he said.

"It's subtle the way those autocalls behave. You're exposed to market risk by definition if you reach maturity, in other words, if you've never been called. Consider that it's a five-year and that you have quarterly observation dates. If you're not called after five years, it means that every three months, the index was down, otherwise you would have got the call. So it just means that on any of these points, you haven't been above 100. If that happens, you would expect to be quite a long way below 100 after five years," he said.

"From a probability standpoint, the chances of finishing at 95 for instance are very small. If you're below 100 every quarter, the distribution expected to be after five years will push down the expected final price. You are probably going to go through the barrier. So the barrier at this point is useless."

The credit riskmap of the notes at 0.53 is slightly more than the average for the product type, which is 0.38, according to the firm's report.

"It's the length of the notes that increases the credit risk here. The three-year expected life, the five-year maturity make it quite a long product," he said.

Price, return

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 price score is exactly average," he said, commenting on a 7.58 score for the product and an average score of 7.57 for the product type.

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, which for this product would be bullish.

The notes have a 7.08 return score, compared with the 6.64 average score for the product type.

"We have a pretty competitive return score," he said.

"Although there is a chance of losing money, there is also a very good chance of getting called and getting the 8% annual return."

'Respectable'

The overall score, which is 7.33 for this product, measures Future Value Consultants' general opinion on the quality of a deal. The score is simply the average of the price score and the return score. The average overall score for this type of note is 7.10.

"It's a respectable product," he said.

"The scores should be looked at as a way to verify that there is no major concern with the investment. For instance, if an investor has this underlying in mind, if that's his particular risk profile, you just want to make sure that the product is not uncompetitive, and this tells you it scores pretty well and that the risk is manageable. So if this is the type of investment that you're looking [for], this particular product does the job."

The notes (Cusip: 40434B230) were scheduled to price Friday and settle Wednesday.

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

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