HSBC’s $10 million trigger autocalls on Russell, S&P, Dow introduce innovative step-down

By Emma Trincal

New York, March 16 – HSBC USA Inc.’s $10 million of 0% step-down trigger autocallable notes due March 10, 2025 linked to the least performing of the Dow Jones industrial average, the Russell 2000 index and the S&P 500 index introduce a set of two barriers on the downside (step-down and downside threshold), which together bring deep protection and a chance to significantly outperform, advisers said.

The advantageous downside features do not penalize the upside as investors can earn up to approximately 10% a year on a cumulative basis, they noted.

The notes will be automatically called at par of $10 plus 9.86% per year if each index closes at or above its call threshold level on any annual observation date, according to a 424B2 filing with the Securities and Exchange Commission.

For each index, the call threshold level will be equal to the initial index level for the first three observation dates and 80% of the initial level for the final observation date.

If the notes are not called, the payout will be par unless any index finishes below its 60% downside threshold level, in which case investors will be exposed to the decline of the least-performing index from its initial level.

Snowball

“This is kind of new. I haven’t seen one like this before. This step down at the end takes a huge amount of risk off the table. And I like those snowballs in general,” said Michael Kalscheur, financial adviser at Castle Wealth Advisors.

In compensation for the higher hurdle, a snowball autocallable pays a cumulative call premium allowing investors to make up for previously missed calls. This compares to a typical Phoenix autocall, which pays a contingent coupon at a lower barrier level than the initial price but does not pay back any lost coupons.

Kalscheur said he liked the issuer, was comfortable with the three well-known U.S. benchmarks and also the four-year tenor.

Back testing

“Even though it’s an autocall, investors must be ready to hold the notes until maturity, and for us, it’s fine. It fits with our buy-and-hold philosophy,” he said.

“That said, chances are you’ll be called out after 12 months.”

Kalscheur keeps historical performance tables for the three underlying indexes. His S&P 500 index figures represent his most reliable set of data as it dates back to 1950.

Looking at one-year rolling periods since that time, he found that the S&P 500 index has finished positive 73.9% of the time.

“You have the other indexes but my numbers on those are more recent. You also have to take into consideration the correlations between the indexes. Obviously that probability is going to be less than 74% of the time, but still. My guess is that you have a pretty high chance of being called out after just one year,” he said.

Step down

What made the structure “unique,” he said, was the step-down.

“If it goes all the way out to four years, you get all the premium all along the way. That’s phenomenal. On a normal basis, the chances of the S&P being down more than 20% over a four-year period are 4.5%,” he said.

“You can look a client in the eyes and say: if you don’t get called in year one, year two or year three, you can make up those payments all the way to maturity.

“If the market is down 10% or 15%, you end up after four years with a positive return of nearly 40%. That’s pretty impressive.”

Deep barrier

Another positive aspect of the structure was the depth of the barrier. Investors will only begin to lose money if the worst-performing index declines by more than 40%.

“If you go point to point and look at the S&P since 1950, a drop of 40% only happened seven days out of 16,700 observations,” he said.

These results are not conclusive, he said, since they only relate to one index.

“It’s just a back-of-the-envelope calculation. But it gives me some comfort. This barrier will protect investors against the destructive impact of a crash.”

“I have a lot of confidence that my risk is limited and reasonable,” he said.

All-time highs

The note would appeal to conservative investors, he added.

“As the market keeps on making new highs, people are getting nervous. The more cautious an investor is, the more they will like something like this,” he said.

“You can take some money off the table, lock it in for four years; if you get called, it’s about 10% a year. That’s fairly good for the highly valued markets that we have.

“It’s hard to find anything wrong with this note.”

Decent income

Steven Foldes, vice-chairman of Evensky & Katz / Foldes Financial Wealth Management, agreed.

“This is a very interesting note,” he said.

“In an environment where clients are starved for income, the potential for 9.86% per year, which is cumulative, is attractive.”

Foldes also liked the barrier.

“The 40% downside protection is appealing even though it’s a worst-of because the correlations among the three are quite high. The idea that one of them could drop more than 40% in four years is very unlikely,” he said.

Tax consequences

He pointed to positive tax considerations.

According to the prospectus, which stressed the “uncertain tax treatment” of the notes, the call premium should be treated as capital gain. This treatment applies to any call premium as long as it occurs more than a year after issuance, which is the case for all premium, starting with the first one to be observed on March 14, 2022.

“Your 10% a year is not ordinary income. It’s going to be treated as long-term capital gain, which is very favorable,” he said.

“This is particularly important for our clients. There’s a lot to like about this note.”

Perhaps the more innovative aspect of the notes was the set of two downside strikes, one for the last cumulative payout, the other for the protection.

“At maturity, you can get the full premium even if you’re down 20%, and you get your full principal back even if the worst index is down 40%,” he said.

Upside focus

If he had to reconstruct the note, Foldes may consider increasing the call premium but only because he considers the amount of protection to be abundant.

“I’d start with the 40% barrier. I’d get rid of it just to see how much it would add to the upside. If it’s significant, I would eliminate the barrier entirely. If not, I would leave it.

“I’d do the same with the 80% barrier that gives you the full 39% premium because it’s probably not necessary.”

Again, Foldes would take action if he could obtain a more significant amount of premium.

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

The Cusip number is 40438U663.

The notes priced on March 9 and settled on March 12.

The fee is 0%.

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