HSBC’s contingent income autocallables tied to three indexes offer solid barrier at maturity

By Emma Trincal

New York, Sept. 10 – HSBC USA Inc.’s contingent income autocallable securities due Sept. 26, 2022 linked to the worst performing of the Euro Stoxx 50 index, the Nikkei 225 index and the S&P 500 index offer such a low barrier at maturity that the odds of losing principal over the seven-year timeframe are limited, financial advisers said.

Instead the risks are not getting paid for a long stretch of time or getting called too early.

Worst of

The payout is structured as a worst of: each index needs to be at or above a particular barrier for some specific events to occur, such as the payment of the coupon, the automatic call or the full repayment of principal at maturity.

Each quarter, the notes will pay a contingent coupon if each index closes at or above its coupon barrier level, 75% of its initial index level, on the determination date for that quarter. The contingent coupon rate is expected to be at least 10.05% per year and will be set at pricing, according to an FWP filing with the Securities and Exchange Commission.

The notes will be automatically called at par of $10 plus the contingent coupon if each index’s closing level is greater than or equal to 95% of its initial level on any of the first 27 quarterly determination dates.

If each index finishes at or above its downside threshold level, 55% of its initial level, the payout at maturity will be par plus the final contingent coupon, if applicable. If the final level of any index is less than its downside threshold level, investors will be fully exposed to the decline of the lowest-performing index.

Deep barrier

“Here is the interesting thing with these autocallables: if things turn ugly, you don’t collect, but you don’t put your principal at risk, at least not before maturity,” said Steve Doucette, financial adviser at Proctor Financial.

“If you’re down by less than 25%, you’re collecting your coupon, but you’re not losing your principal because seven years from now, I can’t imagine the indices being down 45% even if it takes only one of them to put your capital at risk.”

Worst-of notes are riskier when the correlation between the underlying assets is small or negative, he said.

Entry

With three underlying indexes instead of just one, it is more likely that one index will close below its coupon barrier or its downside final barrier, according to the risk section of the prospectus.

“I don’t know about how correlated those indices are. I would have to do some research. What I know is that we had a sell-off and all three indices have pulled back. You’re getting very good entry points on all of them,” he said.

The Nikkei 225 index has lost nearly 12% in the past month while the S&P 500 index declined by 6.30% and the Euro Stoxx 50 index fell by 8.85%.

“The worst-case scenario with those notes is not the risk of losing principal. You’ll be called before that, and even if you’re not, the odds of breaching the 55% threshold seven years out are very small,” he added.

“To me the worst-case scenario would be to go through a bear market for two or three years when you’re not getting any coupon and then get called.

“But you should be able to collect the 10% for a while before getting called away.

“You don’t fall below the 75% level where you get no coupon up to above the 95% threshold when you get called without collecting some income, especially if they check this each quarter. You still have a broad range to get some income before being called.”

Bond substitute

Even if investors do not receive any payment for several successive quarters, they are likely to still earn a competitive yield, he said.

“That’s why I always look at these autocalls as some kind of a fixed-income substitute,” he said.

A certificate of deposit will yield between 1% and 2% and a bond fund between 2% and 5%, he noted.

“Unless you get into high-yield or emerging markets debt, no fixed-income instrument is going to give you anything close to 10%.”

The seven-year maturity is not a concern in his view.

“In general we like shorter-term notes, not longer than three-year,” he said.

“But in this case it’s the exception. I can’t imagine the indices losing 45% seven years from now, assuming that you’re not called before that.”

The notes carry a 3.5% fee.

Doucette said it is not a drawback as he routinely negotiates fees with the issuers.

“We would take the fee out. We would get better terms, more coupon or a greater barrier,” he said.

Matt Medeiros, president and chief executive of the Institute for Wealth Management, was more critical of the product.

“If you pay the fee up front and you get called after three months, you’re getting charged 3.5%. That would be my first consideration before even getting into the analysis of the structure and portfolio,” said Medeiros.

Call protection

“There are a lot of moving parts in this product. You may or may not get the coupon depending on a variety of rules and conditions,” he said.

“It makes it very challenging to come up with a predictable coupon.”

Because getting called too soon can be costly, Medeiros said he would want some adjustment in the terms.

“I would prefer no less than one year before the first call date because at least you have one year to amortize the fee,” he said.

Medeiros agreed that in terms of market risk, the structure is relatively conservative due to the long duration and deep barrier. Yet investors are not buying a bond.

“The probability of being below 45% of the initial price seven years from now is unlikely, but I still wouldn’t position this note as a fixed-income instrument. It’s not predictable,” he said.

“The note provides you with an equity stream. I wouldn’t see it as an income structure.

“If you’re looking for income with a known rate of return, not knowing how much you get paid is a challenge with this one.”

No reliable income

Investors who may buy the notes are willing to forego all the equity upside if they can get the 10% coupon, he said.

But there is no way to know if they will get paid and how much of the coupon they will receive.

“Being called too soon would be a top risk for me. I would need to see a no-call provision for the first year,” he said.

“But there are other issues: the coupon is not predictable [and] all those different triggers add another level of complications.

“So while the risk of losing principal is limited, I would probably not consider this product.”

HSBC Securities (USA) Inc. is the agent. Distribution is through Morgan Stanley Wealth Management.

The notes will price Sept. 21 and settle Sept. 24.

The 3.5% fee consists of a 3% sales commission and 0.5% structuring fee.

The Cusip number is 40434K867.

© 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.