HSBC’s five-year buffered uncapped notes linked to S&P 500 index are aimed at long-term bulls

By Emma Trincal

New York, May 1 – HSBC USA Inc.’s 0% buffered market participation securities due May 29, 2020 linked to the S&P 500 index are designed for long-term bullish investors who favor unlimited upside over leverage, said Tim Vile, structured products analyst at Future Value Consultants.

If the index return is greater than zero, the payout at maturity will be par plus the index return, according to an FWP filing with the Securities and Exchange Commission.

Investors will receive par if the index declines by no more than the buffer level and will lose 1% for every 1% that the index declines beyond the buffer level, which is expected to be at least 15% and will be set at pricing.

“This note is for a pretty bullish investor who is looking for the index to grow over time. Five-year is quite a long maturity. It’s ideal for someone who expects large gains from the index over time.”

The main characteristics of the structure are the absence of any leverage and the uncapped return.

The notes fit into the “unleveraged return” category according to Future Value Consultants’ scoring methodology, which, Vile noted, are less common than their leveraged counterparts.

“You get any gain of the index. At the same time, there is no cap. By getting rid of the leverage the issuer can offer the uncapped return,” he said.

Extending the maturity is also a way to eliminate the cap, which is the case with these notes, probably because there is not a lot of volatility in the S&P 500 index, he said.

The product is not built for moderately bullish investors.

“Investors in the notes anticipate a high level of growth, which is why they think they can do better with no cap,” he explained.

“But it’s not for hugely bullish investors either. This note offers a defensive feature with its 15% buffer. Chances are someone more bullish would give up the protection for the leverage.”

Market risk

Future Value Consultants measures the risk, or “riskmap,” of a product by adding two risk components, the market riskmap and the credit riskmap. Each score is established on a scale of zero to 10 with 10 representing the maximum amount of risk.

The notes have a market riskmap of 2.78, compared with an average score of 2.58 for the product type, according to Future Value Consultants’ research report.

“It’s a bit of a surprise to see that the market riskmap is slightly higher than similar products, even if the difference is small,” he said.

With a 15% buffer and the S&P 500 as the underlying index, one could argue that the notes should present a less risky score.

“The main factor here is the five-year tenor,” he explained.

“Five years is a long period of time that makes it difficult to predict what the index is going to do. A lot can happen in that timeframe, including a correction below the buffer level.”

But when the product’s market riskmap is compared to all products, there is an improvement, he said.

“There you see much less market risk than the average,” he noted, pointing to the 3.25 average market riskmap for all products.

The “all-product” category comprises all notes recently rated by the research firm across all structure types.

“We still have a good buffer compared to barrier notes or notes with no downside protection at all.”

Credit risk

The credit riskmap of the notes is 0.83 versus an average of 0.45 for notes of the same product type.

“There is a lot more time for the issuing bank to default. It’s the time factor that prevails here more than the creditworthiness of the issuer,” he said.

The five-year credit default swap spread for HSBC is 61 basis points, according to Markit. JPMorgan’s and Bank of America’s are 65 bps and 66 bps, respectively. But compared with Morgan Stanley (77 bps) and Goldman Sachs (87 bps), the issuer has a much tighter spread.

Riskmap

The average riskmap for the product type is 3.03. In comparison, the notes showed more risk with a 3.62 riskmap, according to the report.

“The credit risk pushes up the riskmap the most,” he said.

Return score

Future Value Consultants measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions: neutral assumption, bull and bear markets, and high- and low-volatility environments.

The assumption that applies to this product is bullish.

“The return score is excellent mainly because it’s an uncapped structure,” he said, commenting on the 8.64 return score versus a 7.47 average score in this product type.

“In a bullish scenario, the index has a lot of time to appreciate, and there is no limit to the gains,” he said.

“While the riskmap is higher than average, it’s still not that high. It doesn’t have too much of a punishing impact.”

Price score

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10.

The notes have a 7.82 price score, which exceeds the 7.05 average for the category.

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.

“It’s a lot higher than average. The fees are paid over five years, and since we calculate them on an annualized basis, it helps,” he said.

“The high score indicates that this product offers a lot more value than average to the investors.”

Overall score

The overall score measures Future Value Consultants’ general opinion on the quality of a deal. The score is the average of the price score and the return score.

It is 8.23 versus the average for the product type of 7.26.

“It’s a good score. The high return rating really helps. It’s a pretty bullish product designed for long-term investors who are positive about the market five years from now,” he said.

“The fact that there is no cap and that it is linked to a very popular benchmark makes it an attractive proposition.”

The notes (Cusip: 40433BQ35) will price May 26 and settle May 29.

HSBC Securities (USA) Inc. is the underwriter.

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