HSBC’s $8.89 million autocalls linked to Euro Stoxx, Russell offer value with call step-down

By Emma Trincal

New York, Sept. 25 – HSBC USA Inc.’s $8.89 million of 0% autocallable barrier notes with step-up premium and step-down call threshold due Sept. 24, 2024 linked to the lesser performing of the Euro Stoxx 50 index and the Russell 2000 index should appeal to investors who are worried about missing the call, an asset manager said.

“This deal offers a protection against flat to slightly negative markets,” said Russell Catley, asset manager and chief executive officer of Catley Lakeman Securities.

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

Step-down feature

What makes the structure different is the step-down: the call threshold will drop to 95% from 100% on the sixth observation date, which is March 19, 2021.

“Clients like to be called. They get their coupon and their money back. This is why the step-down is a very good feature. The barrier is lower, so it increases the probabilities of getting called.” said Samuel Rosenberg, managing partner at hedge fund Lutetia Capital.

The notes have a memory feature. Any missed call premium will be paid back upon the call, according to the prospectus.

If the notes have not been called at maturity and the least performing index declines below a 70% barrier, investors will be fully exposed to declines in this index. If the worst-performing index finishes below 95% but above the 70% barrier level, investors will get par.

Similar trade

“This is very similar to a JPMorgan deal we just did,” said Catley.

“Our clients like those step-downs a lot.”

The deal he was referring to is a seven-year worst-of autocallable note linked to the S&P 500 index and the Euro Stoxx 50 index. The call premium is 9.08%. The call threshold initially at 100% steps down 5% a year and ends up at 70%. The principal repayment barrier at maturity is 65%.

An important difference however is how low the call threshold ends up being at 70% versus a fixed 95% level with the HSBC notes.

Mutually beneficial

Catley explained how an autocallable step-down may benefit investors.

“If you have an equity book or an alternative book, you’re struggling to find returns. A 9% or 10% return is high,” he said.

“If you don’t believe equity markets are going to perform very well, if you’re worried about the markets being moderately down or even flat, the falling call barrier will give you a greater probability of calling.”

For issuers, the feature may not be as expensive as it appears to be.

“These things will call on average in two or two-and-a-half years. The falling barrier is not going to cost the bank anything.”

On the secondary market, the feature adds value too.

“The return profile on a mark-to-market basis is extremely good,” he said.

Make it cheaper

Rosenberg said that structuring the step-down may not be cheap. But it can be made less expensive.

With the HSBC notes, a longer maturity and a worst-of payout contributed to lower the cost.

The difference between the stated maturity, the actual duration of the notes and the time it takes for the step-down to kick in is also significant in the pricing.

“If the bank expects you to be called before the step-down, obviously it’s not going to cost them anything,” Rosenberg said using an extreme case scenario.

The shorter the time between the implementation of the step-down and the expected duration of the notes, the cheaper the options.

With the HSBC deal, the step-down debuts after 18 months. Catley said that a deal like this one may have an average duration of two years, based on pricing models.

Another way to cheapen the structure is to incrementally lower the step-down, as it is done in the JPMorgan deal, he mentioned, with the call threshold dropping 5% a year.

“It’s always going to cost something but there are ways to make the structure cheaper,” said Rosenberg.

Long is good

Clients and issuers alike may prefer longer maturities when it comes to these kinds of deals, they noted.

Catley stressed the appeal for investors.

“What clients are trying to protect themselves against is a sharp market decline,” he said.

“Markets do fall. It happens every seven to 10 years. You have to structure those deals as long as possible because if you do have a crash, you want to have enough time to recover.”

Rosenberg said that extended maturities help banks price better terms.

“They’re pushing out the maturity to make it less expensive,” he said.

Why so few?

Autocallable notes with step-down call thresholds are being done in the U.S. on a regular basis. But those deals remain relatively sporadic, according to data compiled by Prospect News.

“We do six to 10 of those trades a month, perhaps 100 a year. It’s our biggest product. You see more of these in the U.K.,” said Catley whose firm is based in London.

Asked why step-down autocalls are not more popular in the United States, Catley faulted the banks.

“They’re structuring what they want to get rid of. They’re packaging products that look attractive without really paying attention to what their clients want. It’s a market dictated by the banks,” he said.

For Rosenberg, the product itself despite its appeal was the obstacle.

“It’s a better feature. But it adds complexity. There are so many moving parts...the underlying, the worst-of, the barrier at maturity...you have to explain the step-down. It’s just harder to explain.”

The notes (Cusip: 40435UYC2) settled on Tuesday.

HSBC Securities (USA) Inc. is the agent.

The fee is 2.85%.

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