HSBC's 13-month PLUS linked to S&P 500 with 12%-15% cap aimed at moderate bulls, risk-takers

By Emma Trincal

New York, Jan. 28 - HSBC USA Inc.'s planned 0% Performance Leveraged Upside Securities due March 26, 2012 linked to the S&P 500 index are for moderately bullish investors with a return target in mind and a strong tolerance for risk, said structured products analyst Suzi Hampson at Future Value Consultants.

"They're comfortable with full downside exposure, they know exactly the amount of growth they expect, and they pursue a specific return target they hope to achieve through leverage," she said.

The payout at maturity will be par of $10.00 plus triple any gain in the index, up to a maximum of $11.20 to $11.50 per note. The exact cap will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

Investors will be exposed to any index decline.

Leverage and cap

"These notes are for someone who doesn't expect more growth on the S&P 500 than the cap. It's great if you have a performance target of 10% per annum. If that's your expectation, the leverage gives you a greater chance to reach your goal than investing directly in the index," said Hampson.

Investors should be moderately bullish because it only takes a growth of 4% to 5% in the S&P 500 in order to achieve the maximum return.

Investors in the notes and investors in the index share the same risk profile: They're both fully exposed to the downside, she said, adding that it's on the upside that the two strategies diverge.

"If an investor is comfortable with the cap of 12% to 15% per annum, then this product basically gives them a higher chance of hitting that return but no chance of exceeding it," Hampson said.

"Therefore, it has a less varied return profile than investing in the equity index."

Achieving a higher return with less growth is done through leverage. In order to obtain the leverage, investors have to be willing to tolerate the cap, she explained.

"Investors know the risk involved; they have an idea of the growth they can expect from the S&P. They can assess whether they want leverage with a cap or a direct and uncapped investment in the index," she said.

The notes would not be suitable for investors who would expect the S&P 500 performance to exceed that cap.

"More bullish investors would not want their returns capped. They would invest directly into the S&P 500 since the downside risk is exactly the same," she said.

Deciding on whether or not a cap is appropriate depends on the investor's outlook on the S&P 500. It also depends on current market conditions.

"I think the cap is pretty decent for a one-year. I imagine in current markets most investors would be happy with 12% to 15% per annum," she noted.

The cost of buffering

Investors also have to decide whether they are comfortable investing in a structured note that does not offer any downside protection, Hampson said.

Part of the answer depends on pricing conditions.

The recent decline in the volatility of the S&P 500, which since September has fallen from above 25% to around 19.5%, may explain why more products are being structured without a buffer, said Hampson.

"There are still obviously buffered products, but we're seeing more notes structured without a buffer than before," she said.

If such trend exists - and Hampson said that she is not sure that it is the case yet - the reasons may have to do with volatility levels as volatility impacts the cost of options used to structure the downside protection.

In order to offer a buffer, an issuer needs to sell a put, she explained.

The more volatile the underlying, the greater the probability is of hitting the barrier or the strike.

As a result, the put is more likely to be exercised and the issuer gets better compensated for selling it.

Inversely, the put will be worth less when volatility declines, making the cost of a buffer more expensive, she said.

"With lower volatility, an issuer has the choice between a lower cap or removing the buffer altogether," said Hampson.

"I don't know if I've seen a trend with more deals pricing without a buffer, but it would make sense. As volatility is down, it would be the natural thing to do from the issuer's standpoint."

Risk

The obvious consequence of the absence of a buffer is risk.

Future Value Consultants measures the risk associated with a product with its riskmap rating on a scale from zero to 10. The notes stand at the risky end of the product spectrum with a 5.64 riskmap.

"It's a high riskmap compared to other recently rated products, and that's because there is no buffer," Hampson said.

"Your risk is the same as an equity investor. So it's not surprising that it comes with a high riskmap. As far as risk, this is perhaps the most risky product on the S&P 500 that we have at the moment."

Credit risk is more muted due to the creditworthiness of the issuer.

HSBC's credit default swap spread is only 75 basis points versus 115 bps for Barclays Bank plc, for instance.

"It's a good credit. Investors, though, are still subject to credit risk," she said.

The return rating is more of a mixed bag. This score is Future Value Consultants' indicator, on a scale of zero to 10 of the risk-adjusted return of the notes. The rating for these notes is a 5.03.

"It's average, slightly above average," said Hampson, comparing the score to the average of recently rated products.

The odds of incurring a loss and a gain are 40% and 60%, respectively.

"Other products such as reverse convertibles would make you lose much more money. While the probabilities of losing money are high here, perhaps the amount of losses you might incur is not that high," she added.

"In addition, there is a pretty high chance of making a 10% to 15% return for the year, which gives a quite decent return rating."

Good overall

The notes also fared well for value and overall rating.

The value rating, based on a scale of zero to 10, represents the real value to the investor after deducting the costs the issuer charges in fees and commissions on an annualized basis. The score is 8.45.

"You just have so many products on the S&P 500. They're all tightly priced. This one is a fairly priced one, which gives you the high score," she said.

The overall rating represents on a scale of zero to 10 Future Value Consultants' opinion on the quality of a deal, taking into account costs, structure and risk/return profile.

The notes have a 7.09 overall score, which, based on the chart, is high, Hampson said.

"This is a good overall rating. It compares well with the other products on the market at the moment," she said.

"As long as you understand the return profile and are willing to take on the same risk you would face investing in the fund directly, this product is attractive overall."

The notes (Cusip: 40432R245) will price on Feb. 22 and settle on Feb. 25.

HSBC Securities (USA) Inc. is the agent. It will use all of the fees to pay a sales commission to Morgan Stanley Smith Barney LLC.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.