HSBC’s autocallable market plus notes tied to S&P 500 have ‘merit,’ adviser says

By Emma Trincal

New York, Sept. 21 – HSBC USA Inc.’s 0% autocallable market plus notes due Sept. 27, 2023 linked to the S&P 500 index give investors the opportunity to outperform the market in two different scenarios while offering uncapped and leveraged upside exposure with downside protection over a short investment period, advisers said.

The notes will be automatically called at par plus 9.4% if the final level of the index is equal to or above the initial level on Oct. 7, 2022, according to an FWP filing with the Securities and Exchange Commission.

The final level will be the average of the index closing prices of the five trading days preceding the maturity date.

If not called, the payout at maturity will be par plus 200% of the index return if the final level of the index is at or above its initial price.

The payout will be par if the index’s final level declines by up to 15% of it is initial level.

If the index’s final level declines by more than 15%, investors will be fully exposed to losses.

Credit, fee

Steven Foldes, vice-chairman of Evensky & Katz / Foldes Financial Wealth Management, said many aspects of the structure were positive.

He first looked at the issuer’s creditworthiness.

“HSBC offers a sound credit. Their CDS spreads are the same as Goldman Sachs and very close to Morgan Stanley’s and Citigroup’s, so it appears reasonable,” he said.

The five-year credit default swap spreads of HSBC are 56 basis points, which are identical to Goldman Sachs’ levels, according to Markit. Morgan Stanley and Citigroup have spreads of 53 bps and 50 bps, respectively, based on Markit’s data.

On a less attractive side, Foldes said the “commission is pretty high,” commenting on the 1.5% fee disclosed in the prospectus.

“But we like the two-year tenor. It’s certainly preferable to a five year,” he said.

“We like that it’s not a worst-of but that it’s linked to a single asset class, especially the S&P, which is the best underlying you can have in a note as it reflects how the market is doing.”

Year one

The first type of outcome is the payment of a call premium received after one year if the index is not negative on that first-year observation date.

“Even if you get called, 9.4% is a nice number,” he said.

“You lose 1.4% in dividends, so your real return is 8%.

“But that’s reasonable. Many investors would be satisfied with an annual return of 8%.

“If you don’t get called, you still have a full year to make that back up. Hopefully with the leverage, you’ll get a reasonable number.”

Barrier on two-year

He then examined the leverage scenario in more details.

“You start the second year down since you haven’t been called. But you can still have enough time to get a positive return in the year left,” he noted.

“You get 2x whatever the market gain is, and that number is not capped. That’s an attractive feature,” he said.

“And you have the 15% barrier, which is another plus.”

Over longer tenors, investors do not need a barrier or a buffer, this adviser said. But the need for protection is more significant for shorter-dated products.

“It’s very rare that the S&P would be down over a four- or five-year period.

“But for a two-year, especially as we’re close to all-time highs, you can envision a market decline,” he said.

Foldes said he had not seen this structure before.

“It’s a very interesting note. It’s a creative note. There’s a fair number of things that are very attractive – the short term, the S&P used as the only underlying, the premium of 9.4% as long as you’re up and if you’re not called, the 2x leveraged upside with no cap without mentioning the barrier.

“This note has merit. It’s something we would consider,” he said.

Bad call for big bulls

A financial adviser said he was “intrigued” by the note but could not quite assess its various possible return outcomes.

“I like the issuer. The fee is a little high but that gets cooked into the terms of the notes. It’s tied to one index only and the index is the S&P 500, which is highly visible and straightforward,” this adviser said.

In the call scenario, investors with a sideways or mildly bullish view on the market would be the winners.

“If the market is up, you get 9.4% after one year. That’s not bad. It’s actually pretty good given that it’s not a worst-of,” he said.

“If the market is up 40%, you get 9.4%.

“Obviously, you can’t be too bullish.”

Outperforming on the call

He first assumed the notes would be called in one year, trying to assess the probabilities of return based on back-testing data.

“My statistics show a nearly 74% chance of getting called out after one year,” he said.

This probability is broken down in two sub-segments. 51.7% of the time, the index will increase by more than the 9.4% call premium, a scenario in which the note underperforms the S&P 500 index. The 22.2% remainder is the probability of a gain below 9.4%.

“The note has the potential to outperform the market 22.2% of the time,” he said.

Regardless of whether the notes will “beat” the index, the 9.4% annual return was “very attractive,” compared to a bond, he said.

Even as an equity component, the return met his criteria.

“I always say that I need at least 10% in return when I take equity risk. So, we’re very, very close to my bogey.”

Number crunching

But the note, he said, was more complex because the call after one year was only one possible path. The second path was what happened at maturity if the call failed to occur.

“You’re not in bad shape if the notes don’t get called. At the end of the two years, when the notes mature, you’ll get two times the return with no cap, and you have the 15% contingent protection. Getting those three pieces together...the leverage, the no cap and the barrier...over only two years is very unusual. It’s nice,” he said.

But how likely was the maturity scenario to happen? This adviser said the shortcoming of the note was the difficulty for investors to assess its risk-adjusted return.

“Unfortunately, this is a path-dependent outcome. It’s very hard to model. You have to be negative on year one then positive on year two. I don’t have a way to break that down,” he said.

“I can only use the data over a one-year period or over a two-year period. But I can’t run a scenario reflecting that the call did not take place.

“So, it’s a little bit disappointing for me, a math guy not to be able to verify the probabilities of this note beating the index.

“I would love to see somebody crunching the numbers.

“It’s an intriguing concept. I like the note. I just wish I could model it.”

HSBC Securities (USA) Inc., JPMorgan Chase Bank, NA and J.P. Morgan Securities LLC are the agents.

The notes will price on Sept. 24 and settle on Sept. 29.

The Cusip number is 40439JNA9.

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