HSBC links autocallables to S&P 500; low initial call levels attractive, analyst says

By Kenneth Lim

Boston, Feb. 20 - HSBC USA Inc.'s planned autocallable notes linked to the S&P 500 index has a relatively attractive chance of an early kickout, said structured products analyst Suzi Hampson of Future Value Consultants.

HSBC plans to price zero-coupon semiannual review notes due March 9, 2011 linked to the S&P 500.

The notes may be called for a 13.5% annual yield if the underlying index closes at or above the corresponding call level on each of four valuation dates. On Aug. 19, 2009, the redemption amount is 106.75% of the principal if the index closes at or above the call threshold of 80% of the initial index level. On March 4, 2010, the redemption amount is 113.5% and the call threshold is 90% of the initial level. On Sept. 3, 2010, the redemption amount is 120.25% and the call threshold is the initial index level. On March 4, 2010, the redemption amount is 127% and the call threshold is the initial index level.

If the notes are not called and the index does not decline by more than 10% at maturity, investors will receive par. If the notes are not called and the index declines beyond the 10% buffer, investors will lose 1.1111% for every 1% that the index declines by more than 10%.

Increase in autocallables

Issuers have been offering more autocallable structures recently, Hampson said.

"There's been quite an influx of review-type products," she said. "I think it's probably to do with investors' views or the strategy that they're taking. The kickout products are similar to reverse convertibles in that you're not looking for growth in the index. You're just not looking for a fall."

"As long as the index doesn't fall below 80%, it gets kicked out in six months," she added. "Investors will get the coupon. But for accelerated growth notes for example you need the index to rise in order to get your return."

First call date important

The first call valuation date is generally the most important for autocallable products, because that is when the product is usually most likely to be kicked out, Hampson said.

"I would have thought people who were investing in this product would do so with the kickout in mind," she said. "Most kickouts are more likely to kick out in the first review date for fairly considerable returns. If it doesn't kick out, the product will continue to the end of the term. If it doesn't kick out by the first or second dates, it would suggest the index has fallen by a considerable amount, and once you've gone out past the first two dates, the chance of capital return is quite low."

The HSBC note received a high 7.25 overall rating out of a best possible 10 based on Future Value's assessment metrics. Its risk score was also relatively low at 2.27 out of 10, with 10 being the riskiest.

"This is probably to do with the low sort of trigger levels," Hampson explained. "Because after six months it kicks out if the index hasn't fallen by more than 80%, and 20% is quite a substantial fall in six months."

The initial 80% call threshold and the next 90% threshold are attractive despite the S&P 500's high volatility, she said.

"I think volatility in the S&P is high, but when we do our analysis we do sort of count in a small amount of index growth," she said. "Even if it's volatile, it's 20%. It must still fall 20% in only six months. Basically that's kind of right at the maximum. It would be fairly unexpected I guess if it were to happen."

Even if the notes are not called at the first valuation, investors also have some hope, however slim, that the index could go up again in the future, she added.

"You're not losing your capital yet," she said. "You've still got other opportunities to kick out."

Good enough returns

The one aspect of the note that did not do as well was its return rating, which Future Value assigned a 4.8 out of 10 score, where 10 is the best. The rating reflects the firm's opinion of the risk adjusted return of the product.

But Hampson said the expected returns were still better than risk-free rates.

"The return ratings aren't as high just because your returns are capped," she said. "But compared to risk-free rates you're still getting a good rate of return, even though it's not a headline grabbing number."

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