HSBC’s buffered uncapped notes linked to Russell 2000 fit diverse market views, analyst says

By Emma Trincal

New York, Oct. 30 – HSBC USA Inc.’ 0% buffered uncapped market participation securities due Nov. 30, 2020 linked to the Russell 2000 index show good pricing due to the uncapped return on the upside and a competitive buffer, said Tim Vile, structured products analyst at Future Value Consultants, commenting on his research report on the deal. Those two features may appeal to bears and bulls alike, he added.

The payout at maturity will be par plus any index gain, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by 15% or less and will lose 1% for every 1% decline beyond 15%. The exact buffer will be set at pricing and will be at least 15%.

No limit

“This note is a five-year product with no cap. It’s rare to see no-cap notes. Extending the maturity and eliminating the leverage, as the issuer did with this product, makes it possible for investors to get full upside participation,” Vile said.

“The trade-off is the uncapped return and also here a 15% buffer, which is very appealing.

“Investors could pick this note for several reasons. In fact you could be slightly bearish or strongly bullish either way. In both cases you may find this product attractive.

“A mildly bearish investor would appreciate the15% buffer a lot. You could outperform on the downside or hedge a position in your portfolio.

“At the same time, bulls do not want to be capped. They are confident the market will appreciate sufficiently on its own, so they don’t find the leverage necessary if it comes with a limited upside.

“In general, this is a note that may appeal to cautious investors seeking exposure to the U.S. small-cap market. It could be used as a hedge or as an alternative to a long-only position in the benchmark. The buffer is definitely enticing.”

For some, especially the buy-and-hold type of investor, the five-year maturity can be beneficial too, he explained.

“If you believe that within five years we will have had a bear market or a correction but that there is enough time after that for the index to go back up again, five years may work in your favor. It all depends on your market view,” he said.

Risk

In its research, Future Value Consultants assesses risk, return and price using a variety of proprietary scores in order to compare a product to others. Each score is compared to the average score for products of the same type but also to the average score for all products.

The firm calculates the market risk and the credit risk and adds the two components to generate the “riskmap,” which measures on a scale of zero to 10 the risk associated with a product with 10 as the highest level of risk possible.

The notes have a 2.53 market riskmap, compared with an average of 3.56 for the product type, according to Future Value Consultants’ research report.

“The market risk is very small. It’s one point lower than the average for the same product type,” he said.

The product type in this case is the unleveraged return category.

The Russell 2000 is more volatile than the S&P 500 index, he noted, so a greater market riskmap should have been expected.

“But the 15% buffer offsets the volatility factor. It helps lower the market risk a lot,” he said.

On the credit risk side, however, the riskmap is higher at 0.84, which is twice more than the average credit riskmap for the product type.

“There’s more credit risk. No question about it. It’s definitely due to the longer tenor. HSBC is a creditworthy issuer, so it’s simply a time factor,” he said.

The five-year credit default swap spreads for HSBC are 67 basis points, according to Markit. All large U.S. banks show spreads wider than that by at least 10 bps except for Wells Fargo at 55 bps, according to the financial information services company.

Adding the two risk components, the report reveals a riskmap of 3.57, which is lower than the average of 3.99 for similar products and 3.91 for all products.

The reduced market riskmap offsets the negative effect of the higher credit risk, he said.

Return score

Future Value Consultants measures the risk-adjusted return with its return score.

The return score is calculated based on the best among five market assumptions, which for this particular product would be the bullish scenario.

At 8.74 the return score is nearly equal to the 8.75 average for the structure type. It is also better than the 8.30 average for all products, according to the report.

Vile said that he was “a bit surprised” to see that the product’s return score was equal to and not better than the average given the fact that the risk embedded with the note was lower.

“If you look at the upside and compare this note with similar products you’ll find that the absence of a cap does not make a difference because all those products are themselves already uncapped, or most of them. At the same time, this particular product is less risky, so why doesn’t it score better than the average on the risk-adjusted return scale?

“I think the answer lies in the underlying. The underlying is going to affect the return score in a number of ways: the volatility, the delta, the dividends, etc.

“In any case, there’s nothing wrong with this return score. It’s not any better or worse than the average.”

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 notes have an 8.38 price score, and the average for the product type is 6.27, the report showed.

“It’s a five-year product, so it’s always going to price better than a short-term note. You pay less in annualized fee. The terms help, so it scores quite well – low risk, uncapped return, good size buffer,” he said.

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 overall score for the product is 8.56, compared with an average of 7.51 for its peers and 7.26 for all products.

“It’s very good. Much better than the average,” he said.

“This is a good product in terms of risk and return. You get the full upside exposure, no cap ... [and] protection on your first 15%. This note offers a little bit of everything to both bulls and slightly bearish investors.”

HSBC Securities (USA) Inc. is the agent.

The notes (Cusip: 40433UCN4) will price Nov. 24 and settle Nov. 30.

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