HSBC’s autocalls tied to Euro Stoxx 50 index: better be called sooner than not, analyst says

By Emma Trincal

New York, March 24 – HSBC USA Inc.’s autocallable securities due April 5, 2022 linked to the Euro Stoxx 50 index offer a defensive play even in a bear market, but the notes need to be called in order to avoid high probabilities of losses despite the barrier at maturity, said Tim Mortimer, managing director of Future Value Consultants.

The notes will be called at par of $10 plus a premium of at least 13.55% per year if the index closes at or above the initial level on any annual determination date other than the final one, starting on April 3, 2018, according to an FWP filing with the Securities and Exchange Commission.

If the final index level is greater than or equal to its initial level, the payment at maturity will be $16.775 per $10 of notes. If the index falls but finishes at or above the downside threshold level, 85% of the initial level, the payout at maturity will be par. Otherwise, investors will lose 1% for every 1% that the final level is less than the initial level.

Future Value Consultants produces for its clients detailed stress-test reports with 29 different tables showing different probabilities of outcome under various scenarios for a series of events, based on forward-looking simulations as well as backtesting.

When the notes fail to be automatically called after the fifth and last call point, the index by definition ends up negative.

“Investors will either lose some principal if they breach or they will lose nothing,” said Mortimer.

The report features the “investor scorecard,” which shows the probabilities of calls distributed by call date.

The scorecard indicates that if the notes mature, there is a 29.5% chance of losing money and only a 3.20% probability of benefiting from the barrier and not incurring any loss or gain.

“If you’ve missed the four prior call dates and your notes mature, you’re likely to be significantly down because of time correlation,” he said.

“In order to be below 100 four times over you have to be down a lot.

“You really need to be called not just in order to make money but to avoid losing money.”

50/50

Another table, slightly similar to the scorecard and called “product specific tests,” will show probabilities of calls distributed by call dates as well as probabilities of barrier breach. But the table organizes the data around five market scenarios, which are neutral, bull, bear, less volatile and more volatile.

In a bear scenario, investors have a 50% chance of breaching the barrier, according to this test.

“Even then, it means that you have a 50% chance of being called, even in a bear market where by definition investors lose money,” Mortimer said.

Investors can get a cumulative return of 13.55% on each of the five observation dates.

As it always is the case with autocallables, the chances of a call occurring on the first call date are the greatest, he said.

Even in a bear market, the probability of an autocallable event occurring after one year is 30%, the table showed.

Mortimer specified that the “bear” market simulation used in his model differs from the classic definition of a bear market, implying a price decline of at least 20%.

“It’s just a trending down scenario but one in which you have very high probabilities of losing money if you’re long only,” he said.

Bears die early

Mortimer emphasized the difference between the forward-looking Monte-Carlo tables he just commented on and their equivalent on a backtesting basis.

“If you look at the backtested scorecard, you will see a different set of probabilities on the call points, which points to the short lifespan of a bear market,” he said.

The backtested scorecard results for the past five years simply reflect the actual performance of the index during that time. In that timeframe, the distribution of probabilities by call points varies in a non-linear way.

The first call point sees a 40% probability. The probability for the second call point then drops to 1% only to finally jump back up to 19% on the third annual call date.

“The Euro Stoxx has struggled more over the last five years than the last 10. This explains why after the first call point your chances of being called drop so much and then go back up as the market recovers,” he said.

How often, how much

The scorecard assigns a probability for each outcome with an average outcome, which corresponds to the percentage of losses or gains. A 60% outcome for instance means a 40% loss.

The scorecard shows that in a neutral scenario, investors incur the risk of losing money 30% of the time.

The average outcome for this event is 50%, which means that investors have just as many chances of losing than making money.

The last five

Those results however are based on a Monte-Carlo, forward-looking simulation. The report also shows backtested results. Those reveal a slightly different picture.

In the same neutral environment, looking at the past five-year history, the odds of losing money remain similar at about 29%. But the outcome improves with an expected return of principal of 64% instead of 50%, he said.

Over the last 10 years, the outcome of 63% is similar to the one observed on the past five years. The difference is that the chances of losing money drop significantly to 16% from 29%, according to the backtested scorecard.

Regarding the chances of breaching the barrier, the backtesting results reveal a noticeable contrast between last five years, with a 28% probability and the past decade with a 16% probability.

“You wouldn’t get this distribution with the S&P. The 10-year period in the U.S. would incorporate the 2008 financial crisis,” he said.

“But we’re looking at the European equity market, which has been struggling with the debt crisis and other issues mostly over the past five years. The Euro Stoxx index is still undervalued relative to the S&P.”

In the same way, the odds of a call happening on the first call point are much smaller for the last five-year period with a 39% probability compared to the past 10 years, which showed a 63% probability.

Market neutral

“This note is more defensive than it looks. If you’re in a bear scenario and have a 50% chance of losing money, it may seem risky. But it’s actually less risky than having a long position in a bear market. It’s almost like a market neutral product. Even if the market is down, it still has a chance,” said Mortimer.

“This product still has defensive qualities whereas a straight equity investment would not have that property unless you hedge, but then you’re no longer long.”

HSBC Securities (USA) Inc. is the agent.

The notes (Cusip: 40435H798) will price on March 31 and settle on April 5.

© 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.