HSBC’s autocalls with step-up premium on three indexes to be used as alternative income play

By Emma Trincal

New York, Aug. 26 – HSBC USA Inc.’s 0% autocallable barrier notes with a step-up premium due Sept. 2, 2025 linked to the lesser performing of the Nasdaq-100 index, the Russell 2000 index and the Dow Jones industrial average offer competitive enhanced yield for investors seeking alternative investments for their fixed-income portfolio, advisers said.

The notes will be called at par plus a 13.3% annual call premium if each index closes at or above its initial level on any semiannual observation date, according to an FWP filing with the Securities and Exchange Commission.

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.

“It’s a pretty decent return. Probably a decent level of protection too,” said Steve Doucette, financial adviser at Proctor Financial, adding that he would be hard-pressed to make changes in the structure.

“It’s not a bad note as it stands.”

Margin of safety

The timing of the trade was relatively favorable.

“The Nasdaq had a little bounce but dropped. The Russell is still down and so is the Dow, so your entry is pretty good,” he said.

The notes were expected to price at the close on Friday, a day that saw the Dow Jones industrial average fall 1,000 points in reaction to hawkish remarks from Federal Reserve chairman Jerome Powell in Jackson Hole, Wyo.

The Nasdaq-100 index closed down 25% from its November high after Friday’s volatile session. The Russell 2000 index finished 17% off its January high and the Dow ended 12.6% lower than its peak at the beginning of the year.

Fast moves

Evaluating the 13.3% return was made difficult in the current market environment, characterized by “big drops and big bounces,” he said.

“13% is not a bad return but you never know,” he said.

“Over the past two-and-half years we’ve seen how fast things can turn. In the past, bear markets used to last months or even years, but the Covid bear market of 2020 was over in just a few weeks. This year, we had another 20% drop, but the market recovered in the second half. Now stocks are falling again. You can’t predict anything. We may have a big bounce or a big pullback. Things can really move either way.”

Premium, barrier

The fixed return paid by the note could become a cap on the upside in a rising stock market. On the downside, the barrier provides a limited type of protection, he said.

“Is 30% enough? That’s the hard call. I’m pretty comfortable with it. Even if we’re bouncing up and down, the odds of getting your principal back are pretty good for that timeframe,” he said.

One factor of uncertainty however was whether the economy had already entered a recession and if not, how soon it may happen.

“It’s the wild card. Are we in a recession? If we are, we will go back into correction or bear market model. Some people say that we’re still in a bear market. Who knows? A lot will depend on the Fed’s tightening and if we see inflation numbers go down. The market is a leading indicator. We may be climbing up before we even know we’re in a recession,” he said.

Asset allocation

The memory feature helped offset the risk of holding the notes without earning any payment although it did not completely eliminate it.

“This note lets you cumulate the coupon. That’s good. But if you don’t get called, you don’t earn any return and you could be locked in for three years,” he said.

“The question is do you allocate this to fixed income or to equities?

“I would be inclined to use it as fixed income simply because that’s what it is: a fixed income. You’d get a heck of a return with 13% but a bit of risk too if the barrier gets hit.”

Doucette said he would not use the notes in an equity allocation despite the double-digit return.

“Too much of a risk not to capture the upside. You could easily miss more attractive equity returns if the market bounces back. If you’re not called, you’re stuck in this note for three years and capped at 13%. You could try to get out of the note before it matures to buy equities, but you won’t get fair value because it just never works that way. You’ll have to pay a spread to the issuer.”

He concluded that the notes were more appropriate as a bond replacement than as part of an equity allocation.

“Do I want to take risk on both the upside and the downside just to be in the market? I might as well be long the market,” he said.

“If you treat this note as a fixed-income substitute, it’s reasonable to carry those risks for 13%.”

Sophisticated buyers

Jeff Pietsch, founder of Capital Advisors 360, would also allocate the notes to the fixed-income part of his portfolio.

“It’s a little complicated to explain to a retail investor. But for a sophisticated investor looking for an alternative source of income, as part of an income strategy in a diversified portfolio, it makes a lot of sense,” he said.

Pietsch also liked the timing.

“The trade comes at the right time with the stock market down. You’re getting a pretty compelling entry point,” he said.

Yield enhancement

“I wouldn’t use the notes as equity replacement because you’re not participating in the upside. Your return is limited to the premium. It’s capped,” he said.

The exposure to the worst of three indices was a way to get some premium over traditional bond yields, he added.

“It’s a yield enhancement product with a different kind of payout. But it certainly belongs to a fixed-income portfolio as an alternative source of income,” he said.

The call by definition puts an end to future cash flows, a risk for which noteholders are compensated with the high premium.

“Investors have to accept the rollover risk. They may have a few other similar deals and not be overly concerned about the risk of replacement,” he said.

Investors should also feel comfortable with the barrier level.

“There is market risk, but the odds of hitting a 70% barrier are low. Still, it’s a risk which is why you don’t want it to be a big allocation to your fixed income portfolio,” he said.

HSBC Securities (USA) Inc. is the agent.

The notes are expected to settle on Wednesday.

The Cusip number is 40441XFX3.

The fee is 2.5%.

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