HSBC links Best of Airbag notes to S&P 500; attractive return floor, but risky underlying, adviser says

By Kenneth Lim

Boston, March 12 - HSBC USA Inc.'s planned Best of Airbag notes linked to the S&P 500 index offer high potential returns but have a strong likelihood of being underwater if the trigger is breached, an investment adviser said.

HSBC plans to price zero-coupon Best of Airbag notes due April 1, 2014 linked to the S&P 500.

If the underlying index falls below the trigger level of 50% of its initial level during the life of the notes, investors will receive par plus the index return at maturity. If the trigger level has not been breached, investors will receive 133% to 136% of the principal or par plus the index return, whichever is higher. The contingent minimum return will be set at pricing.

Double-edged trigger

The 50% trigger level appears generous, the adviser said.

"It's amazing some of the barriers and buffers that we've been seeing because of the extremely high volatility in many of these indices," the adviser said. "50% on the downside when the S&P 500 is below 800. That's quite remarkable."

The low trigger level is a reflection of the underlying volatility, the adviser explained.

"The reason they can price it with something like this is the S&P 500 is so volatile right now," the adviser said. "It means there's a reasonable chance that the index can break that trigger. There's no free lunch here. It's 50% because the index is so volatile that 50% can still be profitable."

The trigger works both ways, the adviser said.

"The lower it is, the less likely the trigger event will occur, so 50% is better than 60%," the adviser said. "The flip side of that is once it's been triggered, it's highly unlikely you'll get a positive return at maturity because you'll be in a very deep hole to climb out from."

There is also a higher risk of a trigger event because of the long maturity, the adviser said.

"The longer the note exists, the higher the probability of a trigger event," the adviser said.

Strong headline numbers

But if the trigger event does not occur, the notes are likely to offer a handsome payout, the adviser said.

"If the barrier isn't breached, you get a minimum return of about 6% per year," the adviser said. "That's a very good return, especially because it's a minimum. There's no cap on the upside, so there's no limit to how much you could make on this."

The issuer was probably able to offer the high contingent minimum return and low trigger level because the notes have no principal protection, the adviser said.

"They give you a really good minimum return, but in exchange you have a trigger that, once it's triggered probably means a loss for investors, and there's no floor on your loss, so you could potentially lose all your investment," the adviser said.

The notes could be attractive to investors who do not expect the S&P 500 to fall below 50% of its current levels in the next five years, the adviser said.

"As long as it never falls below 50%, you get at least the minimum return," the adviser said. "So if you don't think that's going to happen, this makes a better investment than investing directly in the S&P 500, because you get at least a 6% return from -50% to 133% or 136%, wherever they set the minimum return, you have full participation in any upside beyond that. The risk is you could lose everything, and you're locked in for five years, so if the trigger event occurs or the issuer has any credit problems during that time, you'll find yourself stuck."

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