HSBC’s 8.95% airbag autocallables tied to Williams offer lower risk exposure to stock

By Emma Trincal

New York, Dec. 14 – HSBC USA Inc.’s 8.95% airbag autocallable yield notes due Dec. 19, 2019 linked to Williams Cos., Inc. shares pay a fixed rate, but as with all autocallables, whether paying a fixed or contingent coupon, the chances of being called on the first observation date are disproportionally high, said Suzi Hampson, structured products analyst at Future Value Consultants.

Interest will be payable monthly, according to an FWP filing with the Securities and Exchange Commission.

The notes will be called at par if the stock closes at or above its initial price on any quarterly observation date.

The payout at maturity will be par unless the final share price is less than the conversion price, in which case the payout will be a number of shares equal to $1,000 divided by the conversion price. The conversion price will be 85% of the initial share price.

Fixed versus contingent

“We don’t see that many autocalls with a fixed rate anymore,” said Hampson.

“But if you compare the probabilities of an early call with the other type of autocalls, those paying the coupon on contingency, it’s very similar.

“Chances are you’ll call after three months regardless of what the coupon is earned.”

However, if the notes do not get called, the two types of products reveal their differences.

“This one offers two benefits compared to the contingent coupon autocall,” she said.

“First, you don’t need to be above a coupon barrier to get paid. You will receive your coupon.

“Second, if you haven’t called, at least you’ve received an 8.95% return. It will protect you partially against losses.

“So, it’s slightly lower risk. For that reason, the coupon you’ll receive with this note will be a little bit lower than what you would earn on a contingency basis.”

Simulation

Future Value Consultants offers stress testing on structured notes, which determine the probabilities of occurrence of outcomes for a specific product and structure type.

The firm’s simulation model is displayed in 29 different tests or tables.

A neutral scenario is the basis of the simulation in all reports. It reflects standard pricing based on the risk-free rate, dividends and volatility of the underlying.

The model runs four other market assumptions based on different index growth rates and volatilities. Those are – bullish, bearish, less volatile and more volatile.

First call

Hampson illustrated the pattern of early call points from one of the tables called “product specific tests.”

The probabilities shown in this table include barrier breach, probabilities of call on the four call “points,” and probabilities of the non-occurrence of a call, which is the maturity outcome.

She first observed figures based on the neutral market scenario.

“This is the same pattern as with contingent coupon notes. There is a 50.6% chance that you’ll be called on the first call point, three months after issuance,” she said commenting the results of the table.

Further away

The decrease in probabilities with time were also in line with any other autocall. The probability of a call on the second quarterly date dropped to 12.1%, to 6.24% in nine months and to 3.38% on the last call date.

“That’s simply because the further you get away from the strike the less likely you will get called,” she said.

The main benefit of the product is that at least investors receive payment even if the notes are not called.

“You have 8.95% in the bank if you never call and that can cushion your losses like a buffer,” she said.

“The stock is down 20%. With the coupon you’ll lose 11.05%.”

The stress testing report on this product is much more “straightforward” than that with a contingent coupon autocallable, she said.

“You would have to add the probabilities of getting one, two, three or four coupons. When you have unpredictable call dates and coupon payment dates, it’s a more difficult product to assess. This one has the advantage of simplicity,” she said.

Market scenarios

Hampson used the same table to compare those probabilities with the four other market scenarios.

In the bull market scenario for instance the chances of a call on the first date is slightly higher at 54.47%. In the bear market, the probability is naturally lower, at 47.15%. On the other hand, the more volatile and less volatile scenarios show little change compared to the neutral assumption with probabilities of a first call of 50.39% and 50.84%, respectively.

“The chances of a call at point one is higher in the bull, less in the bear. That makes sense. What’s interesting here is that the two volatility scenarios aren’t much different from the neutral. This is simply because we’re talking about the stock being at current level. It doesn’t have to move,” she said.

Back testing

Future Value Consultants also offers back-testing analysis. Hampson looked at the back testing for the same table.

In the past five years, the probability of a call on the first date was 58%.

“It’s the normal consequence of having been in a bull market over that period,” she said.

“But typically, you see a great dispersion between the Monte Carlo model and the back-testing results.

“It’s interesting to see that historical analysis mirrors closely the forward-looking model in this case.”

The model also showed the probability of a barrier breach, which was 20.52% under the neutral scenario.

Separately, the “no call occurs,” was an outcome happening 27.6% of the time.

Best case scenario

“If you don’t ever call, you can only hope that the stock will finish above the 85% barrier,” she said.

Such situation is possible but not likely.

It’s also in this scenario – the stock finishes between 85% and 100% – that investors will be paid the full coupon for the entire year.

“The table lets you easily calculate the probability for what is the best scenario,” she said.

By subtracting the probabilities associated with a “barrier breach” from the “no call occurs” outcome (or 27.6%- 20.52%), investors will receive full principal and full annual coupon rate only 7.08% of the time.

“That’s not much. There isn’t a great chance of getting paid the full amount without losing money at the end,” she said.

Investors need to remember they’re buying an autocallable note.

“They have one out of two chances of kicking out after three months with a little bit more than 2% in income,” she said.

“The fixed-income, the barrier, the autocall...all these features make this a lower-risk exposure to the stock.

“But the high chance of a short duration makes it a poor choice for investors only looking for income.”

HSBC Securities (USA) Inc. and UBS Financial Services Inc. are the agents.

The notes will settle on Wednesday.

The Cusip number is 40436A594.

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