HSBC’s trigger performance securities linked to iShares MSCI EAFE to fit strong bullish view

By Emma Trincal

New York, April 10 – HSBC USA Inc.’s 0% trigger performance securities due April 30, 2020 linked to the iShares MSCI EAFE exchange-traded fund have the potential for a strong return, which would appeal to bulls, but the pricing of the notes is disappointing compared to similar products, said Tim Vile, structured products analyst at Future Value Consultants.

The payout at maturity will be par of $10 plus 154% to 164% of any fund gain, with the exact participation rate to be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

If the fund falls but finishes at or above the 75% trigger level, the payout will be par.

If the fund finishes below the trigger level, investors will be fully exposed to the decline.

For bulls

“It’s an interesting product. It’s uncapped, and we don’t see that often. As long as the index rises, you get 1.59 times leverage,” he said.

Vile selected a 1.59 leverage factor, which is the midpoint within the 1.54 to 1.64 range.

“This is for bullish investors. It’s for people who are ambitious about the return they want,” he said.

“A less bullish investor would probably take a cap and seek more leverage.

“Investors in this product have a lot of faith in this index.

“At the same time, a 75% barrier is a reasonable barrier.

“The price would have to drop 25% to hit the barrier, which would be to go from $66.00 to $49.50.”

The ETF closed at $66.26 on Friday and hit its lowest level in the last five years at $46.50 in 2010.

“The stock has been trading up and down from 2010 to 2012. Since then, it has progressively increased. It’s now trading in the $60 to $70 range,” he noted.

“Of course, the index can always go back to its low of five years ago and breach the barrier. Any index can go up or down. But the price has shown a pretty consistent uptrend over the past few years.

“In addition, volatility is not that high. It’s around 20%.”

Investors, however, are still putting their money at risk.

“It’s a five-year note. The barrier can still be breached during that time,” he said.

“Although the risk is not huge, there is still some amount of risk.”

Market riskmap

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.

At 3.43, the market riskmap of the notes is “slightly above average,” he said.

The average market riskmap for the product type, leveraged return, is 3.01, according to Future Value Consultants’ research report.

“Nothing out of the ordinary though. On a five-year term with a 75% barrier, there is a chance to breach the barrier,” he said.

“But with the low volatility, the risk isn’t that high. There’s nothing major investors should be aware of.”

Credit risk

The credit risk, however, is more notable in his view.

The notes have a credit riskmap of 0.81 versus a 0.56 average score for leveraged return products, according to the report.

“That’s more of an issue. Investors should definitely be aware of that type of risk. Credit risk is always higher with longer-dated notes, and this is a five-year term. It’s not a surprise. But the risk is definitely there,” he said.

The credit risk becomes even higher in relative terms when the score is compared to the 0.50 average score for the “all products” category, which includes all notes recently rated by Future Value Consultants across all structure types, including autocallables.

“Credit risk for all products is better because once you kick out, the term is very short, shorter than most leveraged notes,” he explained.

The high credit risk for this product is also due to the issuer’s risk.

“It’s probably a little bit of both – HSBC’s creditworthiness and the duration. But the longer duration is the main factor,” he said.

Overall, the product’s 4.24 riskmap exceeded the 3.57 average for this structure category.

“The high credit risk is what elevates the riskmap,” he said.

High return score

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. The return score is based on the best of the five assumptions.

At 8.43, the product’s return score is high compared to the 7.74 average return score for leveraged notes.

“This return score is very healthy, and that makes sense. For a bullish investor, having no cap and a good participation rate is kind of the ideal combination. We use the best market scenario to produce that score, which is bullish. Based on that assumption, any uncapped leveraged note will always score better than a fixed-income type of product, an autocallable or anything leveraged with a cap,” he said.

Substandard 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 price score of 4.00 is significantly lower than the average for the same product type of 7.33, the report showed.

“It’s quite surprising,” he said, adding that he would have expected a higher price score for two reasons.

The first reason is the relatively long duration of the notes.

“The longer the term, the better the price score because the fees ... are calculated on an annualized basis. Obviously, if the fees are spread over a longer period of time, your score improves.

“Despite the five-year tenor we still have a low price score. It’s unexpected.”

The second factor making the low score somewhat “surprising” is the “relatively high dividend” paid by the underlying benchmark. The dividend yield of the EAFE index is 3.5%.

“High dividends should really help with the pricing, and it doesn’t work that way here,” he said.

“At the end, the low price score suggests that not enough money was spent on the options.”

Overall score

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 notes have a 6.22 overall score. In comparison, the average overall score for this product type is 7.54.

“It’s a disappointing overall [score]. Thanks to the really good return score though, the big picture doesn’t come out too badly at 6.22. It’s not the worst score depending on how investors look at it,” he said.

“But certainly the price score didn’t help. It’s the weak side of this product.

“Still, for the right bullish investor who wants exposure to this index, having no cap and a good participation rate is very attractive. There’s definitely a place in the market for this type of product if you want something that can deliver a higher return.”

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

The notes will price on April 27 and settle on April 30.

The Cusip number is 40434G627.

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