HSBC’s 6% autocallables linked to three indexes show fair pricing with low barrier, fixed rate

By Emma Trincal

New York, Feb. 12 – HSBC USA Inc.’s 6% autocallable yield notes due February 2017 linked to three large-cap equity indexes received a relatively low risk score and appear to be competitively priced – surprising given the worst-of payout and the type of barrier employed.

Other features of the deal outweigh those disadvantages, helping to lower the risk and improve pricing, said Tim Vile, structured products analyst with Future Value Consultants.

The notes are linked to the S&P 500 index, the Euro Stoxx 50 index and the FTSE 100 index, according to an FWP filing with the Securities and Exchange Commission.

Interest is payable quarterly, with the exact percentage to be set at pricing.

The notes will be called at par if each index closes at or above its initial level on any quarterly review date.

The payout at maturity will be par unless any index closes below its 60% trigger level on any day during the life of the notes and any index finishes below its initial level, in which case investors will be fully exposed to the losses of the worst-performing index.

“Several factors contribute to the scores we found when rating this product. One is the type of underlying. We’re dealing with large-cap benchmarks, not single stocks. The fixed coupon and the deep barrier also helped a lot,” said Vile.

Coupon

The notes are designed for fixed-income investors, and guaranteed coupons are less common in the market, he said.

“Most of the time, we see contingent coupons,” he noted.

“When you get a fixed rate it’s usually not that attractive. Here, for this asset class ... equity indices ... the 6% isn’t bad. Volatility is much lower with diversified indexes than with single stocks. You get a fixed income on three large-cap benchmarks.

“But in order to boost the coupon on an index-based product, the issuer usually has two choices: either introducing some contingency as it relates to the coupon or using a worst of. A lot of time, you get both.

“With this one you only get the worst of. Your coupon is guaranteed.”

Future Value Consultants in its research assesses risk, return and price using a variety of proprietary scores in order to compare a product to others. It compares each product to two different averages, same product type and all products recently issued. This note is an autocallable reverse convertible.

Risk

For the risk, Future Value Consultants produces its own metric, the riskmap, which measures the risk on a scale of zero to 10 with 10 as the highest level of risk possible. This measure of risk is the sum of two riskmap components, market risk and credit risk, both calculated on the same scale.

The notes have a 1.10 market riskmap versus an average of 4.28 for the product type.

“You would have expected a higher market riskmap. I am myself surprised by this result,” he said.

He cited the worst-of payout, which increases the odds of a trigger event. In addition, the trigger can be hit any day – a type of barrier called “American” – which adds risk compared to triggers observed at maturity.

Several factors helped lower the risk of market-induced losses.

“The 60% barrier is very low. Any of those indexes would have to drop 40% within the next 12 months to hit the trigger. That’s quite a drop,” he said.

“Also, a worst of carries less risk when the underlying assets are correlated. ... This is pretty much the case here. The large-cap equity markets in the U.S., the U.K. and the euro zone are fairly correlated,” he said.

“The term helps as well. The chances of hitting the barrier are lower on the short period of time. You usually get a lower barrier for longer maturities. This 60% barrier on a one-year is pretty defensive.

“Finally, the autocall feature can reduce the risk. When investors get called automatically, their entire principal is returned and the trade is closed.”

At 0.35, the credit riskmap is on par with the 0.33 average for the autocallable reverse convertible category.

“This is straightforward,” he said. This issuer’s spreads have widened as most European banks, but the short-term exposure to credit risk is a risk-reducing factor, he said.

Return

Future Value Consultants measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions. A risk-adjusted average return for each assumption set is then calculated. The return score is based on the best of the five scenarios.

With this product, the optimal scenario is bullish.

The return score is 6.99 versus an average of 5.80 for similar products and 6.96 for all products.

When rating leveraged notes, the existence of a cap is a factor that may decrease the return score. With this product, however, all notes in the category have a coupon, hence a cap.

“What helps the return score here is the low riskmap,” he said.

Value

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 also comes as a surprise given the short term. You would have expected something lower than that,” he said.

Any short-term product tends to score lower on the price scale, he explained. The notes are not only short in duration, they can be automatically called, cutting the potential length of the investment to only three months.

“It shouldn’t help the price score. If the product kicks out after three months, investors will have paid the fee upfront and won’t be too happy about getting only 1.5%,” he said.

Yet the score suggests that the product offers more value than its peers in terms of cost per annum, he noted.

“They probably spent a decent amount on the assets. They put in the structure a low barrier and a coupon, and it’s a one-year product. This has value,” he said.

Another explanation may be how banks price index-linked notes. As the risk involved with the pricing of index options is considerably lower than with single stocks, banks tend to take smaller profit margins, 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 notes show a 7.76 overall score versus an average of 5.51 for similar notes with autocallable features and fixed coupons.

“For investors looking for an above-average coupon, for those who don’t believe the market is going to crash short term, this is a pretty decent note. You get exposure to the U.S. and European markets with a guaranteed coupon and a fairly substantial barrier protection,” he said.

HSBC Securities (USA) Inc. is the agent.

The notes will price and settle in February.

The Cusip number is 40433UHS8.

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