HSBC to price principal-protected notes on S&P with short tenor, no call feature

By Emma Trincal

New York, Oct. 28 – HSBC USA Inc.’s 0% market participation securities due May 3, 2024 tied to the S&P 500 index demonstrate how rising interest rates are now allowing issuers to price principal-protected notes without subjecting investors to extra-long maturities or call options.

If the return of the index is positive, the payout at maturity will be par plus the return of the index, capped at par plus 12.2%, according to an FWP filing with the Securities and Exchange Commission.

If the index finishes flat or declines, investors will receive par.

Short is sweet

“That sounds great! Sign me up. I’ve never seen such a short principal-protected note. That’s a great product for conservative investors,” a trader said.

“A 12% cap over 18 months with no downside risk is amazing.”

Most principal-protected notes on a single index like the S&P 500 show at least a five-year tenor, he said.

For two- to four-year maturities, the structure usually includes a single autocall, which is generally observed at the end of the first year.

A financial adviser also liked the terms.

“It’s a good deal. It’s a short, bullet note with upside participation up to a cap. No downside risk. I’ve not seen something like that before,” he said.

“The market is down right now. Call options are cheap. I guess that’s how they were able to do that.”

Bond profile

Seve Doucette, financial adviser with Proctor Financial, said the notes may be appropriate for a particular type of client.

“It might be great for a conservative investor who wants to get into the market with principal protection. Your cap is about 8% a year. It looks good for people who are sitting on the sidelines,” he said.

“For fixed-income replacement, if you hit 12%, it’s a pretty nice rate of return.”

The notes however do not fit the exact definition of fixed-income, he said.

“There is no income. It’s equity-based. You participate in the upside, and you get paid at maturity,” he noted.

Yet Doucette would still use the product as fixed-income replacement from a risk standpoint.

“You have zero exposure to the downside,” he said.

Fear of missing out

There was another reason: this adviser would be reluctant to allocate the notes to his equity bucket.

“We don’t know where the market is going to be at maturity. We could be down and come back up. I wouldn’t take any equity exposure off the table,” he said.

Bear markets tend to be short-lived, he noted.

“We’ve been in this negative cycle for 10 months. We might have gone through the worst already,” he said.

The S&P 500 index closed on Thursday 21% off its Jan. 4 peak.

“Eighteen months from now, you may regret going for a 12% cap if we come back strong.

“But as fixed-income replacement, you get a decent rate of return. It’s very simple to explain. A lot of clients would be very comfortable with that,” he said.

Two risks

Investors are facing the opposite risk if the market continues to decline and interest rates rise.

“You could be up only 5% and not 12%. If both stocks and bond prices continue to fall, the yield on your note may end up being pretty low compared to what’s out there,” he said.

Some money markets offer yields of 3% while Treasury rates exceed 4%, he noted.

“You’re just reaching out for an extra 4% without the guaranteed coupon when you buy this.

“So, if we have a big rally, you may underperform the stock market. If stocks go down and rates continue to rise, you may not get a competitive coupon.

“But it’s still attractive to have no downside exposure to the market over that short period of time,” he said.

No barrier, no buffer

A buysider would allocate the notes in his equity portfolio but for risk-averse clients.

“It’s principal-protected with growth up to 12% on 18-month. You have the counterparty risk, but it’s a short duration. I haven’t seen many deals like this. I know a lot of people who would find it very attractive,” he said.

“It’s a pretty interesting way to get some level of equity participation without putting your principal at risk.”

“For an 18-month note, it’s an intriguing alternative to the traditional barrier or buffer product.”

HSBC Securities (USA) Inc. is the agent.

The notes priced on Monday and will settle on Thursday.

The Cusip number is 40441XSD3.

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