HSBC’s step down trigger autocalls on Nasdaq, Russell show different return outcomes

By Emma Trincal

New York, Jan. 25 – HSBC USA Inc.’s 0% step down trigger autocallable notes due Jan. 31, 2024 linked to the least performing of the Nasdaq 100 index and the Russell 2000 index show slightly different possible outcomes than a standard autocallable note due to the step-down feature, said Suzi Hampson, head of research at Future Value Consultants.

The notes will be called at par of $10 plus an annual call premium of 7.85% to 8.85% if each index closes at or above its initial level on any annual review date after one year or at or above its 70% downside threshold on the final date, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called, the payout at maturity will be par plus the return of the worse performing index with full exposure to any losses.

No Phoenix

The structure offered three particularities with the step down being the most interesting one, she said.

“This product is a straight autocall. You are not getting any coupon. You’re getting a call premium when you kick out, not when you’re above a coupon barrier like the common Phoenix autocall type,” she explained.

So-called Phoenix autocallable structures tend to have a coupon barrier set below the call trigger set at the initial price. The two distinct strikes make the income payment event more likely than the call. In theory, investors can cumulate several coupon payments while the notes are still “live.”

Memory

Another characteristic of this product is the cumulative call premium, she said.

“If you don’t kick out on the first year and miss the 8% payout, you will get 16% next time on year two. You don’t miss any payout as long as you call. We sometimes call this feature a snowball,” she said.

The term “memory coupon” is often used as well.

She explained how the structure was different from a Phoenix.

“Here it’s like having an income autocall with an income barrier of 100. It’s a bit harder to call and get paid. So you expect your call premium to be higher than with the Phoenix. The chances of being paid are lower given the higher threshold,” she explained.

Another characteristic of the notes is the underlying. As many income deals, this product is based on the least performing index.

“This is a worst-of, which is not unusual for autocallables today. Most of them are structured that way,” she said.

Step down feature

The step down was the most unusual and interest characteristic, she noted.

While the first four calls are triggered at par level, the last one (at maturity) is offered at a more achievable level when both indexes are above 70% of their initial price. This level is identical to the principal repayment barrier at maturity.

“The step down makes it easier to get paid but it only occurs at maturity. Does it change the typical probabilities of calls and dates of calls? It does to some degree,” she said.

For the purpose of her analysis, Hampson picked a call premium of 8.35% at midpoint of the range. She first focused on the product specific tests, one of the 29 tables displayed in the report she ran for this product.

Specific tests

Future Value Consultants offers stress testing on structured notes determining the probabilities of occurrence of outcomes.

The probabilities displayed in the product specific tests reflect the characteristics of the structure: probability of barrier breach, probabilities of call at any of the five various dates and finally, probabilities of the absence of a call.

Probabilities are distributed across several market scenarios. The neutral scenario is the basis of the Monte Carlo simulation in all reports. It is the most frequently used as well.

More to come

The table showed for the neutral scenario a 48.51% chance of a call occurring at point one (on the first annual call date).

“This is in line with the results seen with all autocallables. Probabilities are always the greatest for the first call date, and that’s what people usually expect,” she said.

The probabilities of an automatic call then decline with time: 12.33% at point two, 6.14% at point three and finally 3.91% at point four, which remains typical. But the pattern changes for the last call date at point five when the probability suddenly rises to 11.38%.

“You would never see that without the step down. In a normal distribution, the last call is always the least likely to happen and the chances are usually very, very small,” she said.

“Here the probabilities increase at the end because it’s easier to be above the 70% barrier than above 100.”

“It may seem like a very low probability. But what’s interesting here is the reverse in the trend. You do have a better shot at getting the maximum return with the step down. That’s what it’s designed for,” she noted.

Back testing confirmation

One way to test how the step down has “helped” is to review the back-testing table, she added.

Unlike the Monte Carlo simulation, which is forward-looking, the back-testing version of the product specific tests showed the frequency of occurrence for the previous outcomes based on the past five, 10 and 15 years.

Over the past five years, the notes would have been called at point one and two 99.84% of the time. The point three showed a negligible probability of 0.16%. The last call date featured no occurrence.

“This goes against what we observed so far. You have zero chances of calling at the end. But this has nothing to do with the step down. It’s just a consequence of the strong bull market we had. The likelihood of calling are so high in this environment that it’s going to happen before the last call date,” she said.

In fact, the past five-year back-testing results offered similarities with the bull scenario run on the Monte Carlo simulation, she noted.

“In that bullish market the 70% step down doesn’t do anything for you. Everybody is happy anyway.”

Time machine

Things start to change when looking back further in the past when the impact of the bull market was more muted.

“For the last 10 years, the results are becoming more similar to our simulation. We see rising probabilities of a call at point five, which is the sign that the barrier has an impact here,” she said.

The difference is subtle but clearly breaks the pattern of probability distribution invariably observed with the traditional structures designed to call at par, she added. During that 10-year period, the chances of a call at point four are 4.99% but increase to 7.07% at point five.

The same sequence of distribution is also seen for the last 15 years, from 4.87% at point four to 8.46% at point five.

“It does help to have the step down. We see results closer to our simulation: a high probability of calling at point one, then decreasing chances of calls and finally, a turn with probabilities going up again at point five,” she said.

“If the call level was at 100 all the time, you would expect that last probability to be much lower.”

First call date

As it remains the case, regardless of the type of autocall and whether the analysis is forward-looking or based on past results, investors are most likely to see their notes called on the first date. The chances are 72.14% for the past 15 years. Over the past five years, when the bull market was the most robust, that same first call occurred 86.57% of the time, according to the back-testing table.

All or some

Another table in the simulation model called investor scorecard will give an idea of what happens when the notes reach maturity. In this table, 11.38% of the time, the call at point five will occur. In addition, 17.73% of the time, the barrier will be breached causing some capital loss, the table showed.

“Once you skip the first four calls, it’s a binary result. You either kick out on the last call or you lose money,” she said.

Adding the two probabilities – 11.38% and 17.73% – reveals a probability for investors to hold the notes throughout the entire five-year term of about 29%. When this happens, the odds are skewed toward losing principal rather than collecting the full payment at 60% and 40%, respectively.

“There is risk of losing money with any autocall that doesn’t kick out. What’s interesting here is that the step down increases your chances of a big return at the end,” she said.

“It’s a good thing that people don’t buy autocalls with the expectation of getting the coupon until the end. This is not what those products are designed for. Quite often the probability of not calling is small.

“This product changes the distribution of probabilities quite dramatically. You’re much more likely to get the maximum return at the end.

“It changes the shape of the outcomes.”

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

The notes will price on Jan. 29.

The Cusip number is 40436A412.

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