HSBC's leveraged notes tied to Euro Stoxx offer high risk-adjusted return, competitive pricing

By Emma Trincal

New York, July 12 - HSBC USA Inc.'s 0% return enhanced notes due July 18, 2018 linked to the Euro Stoxx 50 index are competitively priced for bulls seeking exposure to the European stock market, said Eve Berlinska, structured products analyst at Future Value Consultants.

The payout at maturity will be par plus 2.1 times any gain in the index. Investors will be fully exposed to any losses, according to an FWP filing with the Securities and Exchange Commission.

"Despite the absence of any downside protection, the notes offer an enticing potential return, which is why this product scores well above average," she said.

"This is a leveraged return product, the most popular category in the U.S.

"There is a 210% participation in the growth of the underlying, which is the Euro Stoxx 50. It has no cap on the upside and no protection at all.

"It would appeal to a very bullish investor, someone who wants the index to grow as much as possible and who is not too concerned with the downside risk because they expect the index to rise.

"The notes are also targeting investors who want exposure to the European equity market but in a different way than a direct investment in the index."

Riskmap

The notes are not a good fit for risk-averse investors, she said.

"Investors in these notes have to be prepared to lose a significant amount of money if their bullish bet turns out to be wrong," she said.

Future Value Consultants rates the risk associated with a product on a scale of zero to 10 with its riskmap. The higher the riskmap, the higher the risk of the product. The riskmap is the sum of two risk components: market risk and credit risk.

The notes' credit riskmap is 0.56, compared with an average credit riskmap of 0.64 for products of the same type. The average credit riskmap for all products is 0.48, according to the research firm's report.

The product type is defined as all leveraged notes with or without downside protection.

"The credit risk is higher than the average of all products given the long duration of the notes, especially if you compare it to all products, which for the majority are reverse convertibles," she said.

"On the other hand, the credit risk is close to the average of the same product type. One would expect a higher credit risk with a five-year note, but it's not really the case here since the difference in scores between the product and comparable notes is slim."

One explanation may be a recent lengthening of duration in the leveraged products category, she added.

"We've seen durations getting a bit longer for this category of products this month, which may explain the slight difference. Also, HSBC's credit is quite good. Its credit default spreads at 110 basis points are tighter than a number of other firms," she said.

The market riskmap comparison is more straightforward, she said. The product's 4.89 market riskmap is well above the all-products score of 3.40 and even higher than the same product type at 2.76.

"The notes show a higher market riskmap overall," she said.

"That's essentially because there is no downside protection. Usually, we have an American or a European type of barrier or a buffer. With this one, we don't have anything.

"In addition, the underlying volatility of the Euro Stoxx index is 20%, slightly higher than 16% for the S&P."

With the riskmap adding the two risk components - credit and market - the notes end up with a high riskmap of 5.44 compared to the average similar product, which shows a 3.40 riskmap. The score is also greater than the average riskmap for all products, which is 3.88.

"The two main risk factors in this note are duration and the lack of protection. They make the product more risky than most," she said.

"But the higher risk is somewhat offset by the high return potential," she said, commenting on the elevated return score.

High risk-adjusted return

The return score is Future Value Consultants' measure of the risk-adjusted return. The rating is calculated using five key market assumptions: neutral assumption, bull and bear markets and high- and low-volatility environments. 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 best scenario would be bullish, Berlinska said.

The notes have a 9.54 return score, which is higher than the 7.56 average return score for similar products and also better than the 6.73 average return score for all products.

"It's really higher than both categories, mainly because there is no cap on the return, which gives the underlying index a chance to rise significantly, especially on a five-year period. There is no limit to the rise," she said.

Probability tables

With its probability chart, Future Value Consultants estimates how the product is expected to perform under the five key assumptions. It assigns a probability of return outcome to each of the payoff buckets.

"Under the bullish market assumption, which we've used here to compute the return score, there is 37% probability for the investor to get an annual return in excess of 15%. That's high," she said.

The probability of losing the same amount is 7.5%.

"There is risk, but given the amount of risk taken, the issuer offers a strong potential return to investors with the combination of having no cap and getting more than two-times leverage," she said.

"The five-year duration also plays a role because there is more time for the index to grow over a longer period of time.

"There is no protection, but this product is designed for bulls. The issuer offers very competitive terms on the upside in order to attract investors. The potential return should appeal to investors who are bullish on the European market.

"This note also offers an attractive alternative to a direct investment in the index because an equivalent leveraged fund would give you the leveraged exposure on the downside while this note doesn't, so that's an additional benefit."

Price score

Future Value Consultants measures a note's value to the investor on a scale of zero to 10 with the price score. 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 for the notes is 9.44. The average of similar products and the average of all products is 7.71 and 6.84, respectively, according to the report.

"This very good score indicates that the product offers great value. The issuer spent a decent amount of money on the options. The duration is also factor because the fees are taken only once, which reflects a more favorable pricing than a one- or two-year note," she said.

Overall score

Future Value Consultants offers its opinion on the quality of a deal with its overall score. The score is simply the average of the price score and the return score.

"Because the price score and the return score are high, the overall score is also going to be high," Berlinska said.

The notes have a 9.49 overall score. Compared to 7.64 for the same product type and 6.79 for the average of all products, "the higher score suggests a very attractive pricing and risk-adjusted return," she added.

"That type of overall score is not that common. It's one of the best ones we've seen in recent months.

"The combination of having no cap and getting a 210% participation in the upside, which is pretty high, make this product quite compelling."

HSBC Securities (USA) Inc. is the agent.

The notes were expected to price Friday and settle Wednesday.

The Cusip number is 40432XHW4.

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