HSBC’s $1.11 million autocallable barrier notes offer strong premium with memory

By Emma Trincal

New York, July 22 – HSBC USA Inc.’s $1.11 million of 0% autocallable barrier notes with a step-up premium due July 13, 2026 linked to the lesser performing of the Russell 2000 index, the Nasdaq-100 index and the Euro Stoxx 50 index give investors the benefit of a memory premium, which reduces the risk of missing payments during a market downturn. The tradeoff is the exposure to the worst of three indexes, which are not highly correlated to one another, advisers said.

The notes will be called at par plus an 11.52% annualized call premium if each index closes at or above its initial level on any semiannual observation date after one year, according to a 424B2 filing with the Securities and Exchange Commission. Previously unpaid call premiums will also be paid.

If the notes are not called, the payout will be par unless any index has finished below its 70% barrier level, in which case investors will lose 1% for each 1% decline of the least-performing index from its initial level.

Good memory

A coupon or call premium has a memory when the payout carries over to the next observation date, allowing investors to accumulate all previously unpaid payments The memory is the term most associated with so-called “snowball” structures.

Steve Doucette, financial adviser at Proctor Financial, said the cumulative nature of the call premium was what made the notes appealing, along with the return.

“The odds of collecting that memory coupon are pretty good. You're likely to be called before the end of the five years, and you’re still collecting the coupons that you've missed before,” he said.

Tenor, premium

Doucette said the five-year term may have not been his first choice.

“You could get caught down five years from now. It’s unlikely but who knows?

“The market is going to pull back. The question is when.”

“We usually try to keep it short. It would be interesting to see what you can get on a three-year or even four-year.”

Doucette added two other terms he found attractive.

“If you’re not expecting outsized returns like we’ve had in the last three years, the 11% cap is pretty nice to collect. It’s above 10%. You could easily outperform if you’re correct.”

Most analysts forecast returns below 10% in the next five years, he noted.

The advisor said he also liked the one-year call protection.

“If you don't need to roll these things over, it's nice to have a return for at least a year, as opposed to three months, or six months.”

Capped out, no buffer

Matt Medeiros, president and chief executive officer of the Institute for Wealth Management, pointed to what he called “variables,” or factors making the return outcome too uncertain for him to consider the notes.

“I like longer term notes now, especially on broader indices. If it was a shorter term, I would be concerned,” he said.

“Five years is fine. The problem I have with this note is that it’s capped,” he said.

“I’m not getting rewarded for holding the notes for five years if I’m capped out.”

He conceded that the notes may not have a five-year duration if called.

“But you have to assume it’s a five-year holding period because you don’t know if the call will be triggered or not.”

The type of protection was another risk, which he said was hard to mitigate.

“It’s a barrier. To me, a barrier means that I don't really know specifically if I'm going to get a protection or not,” he said.

“A barrier is not like a buffer. Once breached, no more protection! It’s a major factor of uncertainty. A buffer on the other hand gives you a fixed percentage of protection. I always prefer having a buffer.”

Disparate underliers

Medeiros said that the third “variable” was the worst-of payout.

Even though he said he liked the three underlying indexes as key pieces of a diversified portfolio, the exposure to the worst-performing index was a major drawback.

“I like those three indices. If it was a weighted average basket, it would be much more appealing to me,” he said.

But investors in worst-of lower their risk with more correlation, not less, he said, adding that the correlations between the three indexes were not high.

“That’s a concern.”

For example, the five-year coefficient of correlation between the Euro Stoxx 50 index and the Nasdaq-100 index is 0.74 on a scale of 0 to 1, with 1 indicating perfect correlation.

In comparison the Dow Jones industrial average and the S&P 500 index for instance – two large-cap benchmarks show a 0.962 coefficient of correlation over a five-year period.

Medeiros underlined the disparity between the three indexes. The Nasdaq-100 represents the U.S. mega tech stocks, the Russell 2000 index, the U.S. small-cap universe and the Euro Stoxx 50 index is a concentrated benchmark of European large-cap stocks.

“It’s a little bit apples and oranges,” he said.

One of the indexes could drop while another could rise, which increased the odds of a negative outcome.

“There is too much risk in there, too much uncertainty. The note is not appealing to me.”

HSBC Securities (USA) Inc. is the agent.

The notes settled on July 13.

The Cusip number is 40439JFU4.

The fee is 0.65%.

© 2015 Prospect News.
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