HSBC’s $20.25 million of step-up autocalls on basket of bank stocks provide high premium

By Emma Trincal

New York, Feb. 3 – HSBC USA Inc.’s $20.25 million of 0% autocallable market-linked step-up notes due Jan. 26, 2024 tied to a basket of three bank stocks are geared toward mildly bullish investors unconcerned with the downside risk exposure and willing to maximize their chance of getting a higher return, sources said.

The equally weighted basket is made up of the common stocks of Citigroup, Inc., JPMorgan Chase & Co. and Morgan Stanley, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par of $10 plus an annualized call premium of 17.3% if the basket closes at or above the initial level on an annual observation date.

If the notes are not called and the basket finishes above the step-up value, 145% of the initial level, the payout at maturity will be par plus the basket gain.

If the basket finishes at or below the step-up level but at or above the initial level, the payout will be par plus the step-up payment of 45%.

Investors will be fully exposed to any basket decline.

Snowball

“Bank stocks are up a lot,” an industry source said.

“The 17% premium is attractive. That’s the reason why there’s no downside protection. Also, you don’t need to pay a periodic coupon. It’s a snowball. That too helps boost the yield.”

So-called “snowballs” are a type of autocallable in which investors get paid only when the notes get called. Typically, call premium accumulates so that missed payments can be captured when the notes are called later.

“The fact that it’s a basket, not a worst-of is certainly good,” he added.

“But normally clients who push for income products also seek some level of protection.”

He said the unlimited upside at maturity if the basket finishes above the step-up level was a compelling yet unlikely outcome.

“The reality is your call premium is going to cap your upside; meanwhile, there is nothing there to protect you against losses,” he said.

“In theory you have uncapped gains at maturity but that’s assuming you don’t get called within the three years, which is doubtful.

“So yes, the call premium is high but it’s at the expense of the protection.”

Equity-like gains

A market participant said the notes were designed for mildly bullish investors seeking to beat the basket performance.

“It’s a pure equity strategy play on bank stocks. You look at this as an alternative to buying the shares directly,” he said.

“You want the basket to be slightly positive. It doesn’t have to be up dramatically. That’s how you can outperform the basket with a note like that. You get called away at a premium that exceeds the intrinsic value of the stocks.”

This market participant agreed the premium was generous.

“17% is pretty high,” he said.

“Having no buffer or barrier certainly allows the economics to go to the upside.”

Low volatility

The premium was all the more impressive that volatility was not at its highest on the trade date.

The deal priced on Jan. 28 after earnings releases for all three banks.

JPMorgan and Citigroup reported their first-quarter results on Jan. 15, and Morgan Stanley released its fourth-quarter earnings on Jan. 20.

“Volatility tends to pick up ahead of earnings because nobody knows if the numbers will be good or bad,” this market participant said.

“After the announcement, volatility generally declines.

“Since the deal came one or two weeks after the announcement, presumably the lower volatility would work against the terms. And still they were able to come up with a 17% premium.

“Plus, it’s a basket, not a worst-of, which also reduced the volatility.

“It looks like pricing was really good. The size shows it caught investors’ interest. Since it was a Merrill deal, certainly it must have been sold to many different clients, not just one.”

BofA Securities, Inc. is the agent.

The Cusip number is 40438Q191.

The fee is 2%.

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