HSBC’s $2.5 million autocall tied to four stocks offer value-like play, higher call risk

By Emma Trincal

New York, Jan. 4 – Notes tied to stocks, especially with worst-of payouts, have become less common over the past few months, but HSBC recently showed notes tied to the worst of four high-dividend stocks.

HSBC USA Inc. priced $2.5 million of autocallable contingent income barrier notes due Dec. 29, 2025 linked to the least performing of the stocks of Johnson & Johnson, Verizon Communications Inc., Goldman Sachs Group, Inc. and Intel Corp., according to a 424B2 filing with the Securities and Exchange Commission.

The notes will pay a contingent quarterly coupon at an annualized rate of 17% if each stock closes at or above its coupon trigger level, 60% of its initial level, on the observation date for that period.

The notes will be called at par plus the coupon if each stock closes at or above 90% of its initial level on any quarterly call observation date.

If the notes are not called and each stock finishes at or above its 60% barrier value, the payout at maturity will be par plus the final coupon. Otherwise, investors will be fully exposed to the decline of the least-performing stock from its initial level.

High-yielding stocks

Many worst-of tied to stocks in the past used mega-cap tech stocks for their high volatility, noted a market participant.

“Here, the kinds of stocks they used tend to be less volatile. That is not going to enhance your coupon. I mean, lower volatility will hurt pricing. You’re going to have to find some premium elsewhere, and here, it’s through the dividends.”

The dividend yield of Verizon is 6.6% and that of Intel, 5.5%. Both yields are well above the 1.77% dividend rate paid by the S&P 500 index. The dividend yields of Goldman Sachs and Intel (2.9% at 2.5%, respectively) also exceed the benchmark’s yield.

“This is one of the ways they can structure a 17% coupon,” he said.

Investors in structured notes do not receive the dividend payments of the underlying assets. Those instead are used by the issuer to buy the necessary options.

Worst-of

The other factor, which allowed the issuer to extract more premium, was the use of four stocks in the worst-of, he said. The greater the number of underliers, the greater the dispersion risk, which generates higher coupons.

The choice of the underliers, which are value rather than growth stocks, offered some contrast with the more commonly used technology names, he added.

“This may suggest a move in the market toward value. Maybe,” he said.

As the tech sector plummeted last year, the popularity of large-cap growth stocks has also receded in recent structures.

Easy call

Another characteristic of the deal was the “step-down” at 90%, which triggers the call at a lower level than par.

“The dividends help boost the coupon. But the structure of the call doesn’t,” he said.

“At 90, you’re more likely to get called than at 100, therefore, it’s safer for you. Whenever something is less risky, you get paid less.”

Advisers often debate with their clients about the respective benefits of holding a note until maturity if they can versus incurring an automatic call early on. For this market participant, the answer to this question was clear.

“Everybody wants to get called. People in general want to avoid the risk of breaching the barrier at maturity and being long the stock. A lower call threshold gives investors a better deal,” he said.

Call risk

The perception of what a “better deal” is, however, varies. Advisers tend to prefer notes that pay the coupon for longer periods of time.

“This note is not going to work for advisers who don’t want to be called in three or six months. I’ve seen advisers who complain about being called too early. To me, they have irrational expectations. They want to get paid 17% until maturity without taking on any risk. They might as well say: can you write me a check every month?” he said.

Brokers at the wirehouses have different expectations, he said.

“If you get a fee, a call is an opportunity to make money.”

Fee-based advisers in contrast do not stand to benefit from repeated calls.

“I can understand they may not want to spend the time looking for another deal and talk to the client. They’d rather spend time looking for new clients,” he said.

“But it’s not a winning attitude. They got called. But they made 17% a year. It’s a win. Why complain when you won?”

Call risk, equity risk

A financial adviser had a different take.

“I have that conversation sometimes with banks. They don’t always understand that it’s not just a high-yield that advisers want for their clients. We want a return with good risk. If the risk is limited at maturity, you want to be on that note as long as possible,” he said.

“To me, a 60% barrier at maturity on a three-year is pretty much limited risk even with four stocks.”

The tradeoff for investors was the high likelihood of not earning the coupon during the entire term.

“Chances are you’ll be on that trade for a year, maybe a year-and-a-half tops,” he said.

The choice of stocks mitigated some of the risk, he added.

The issuer picked “conservative” names, he said, which clients in retirement may want to own in their portfolio for income.

“Rather than owning the stocks and getting a 4% dividend, why not earn a 17% coupon with less risk?

“It’s a deep barrier and those four are pretty low volatility guys. It’s not like betting on Tesla.

“It’s a good trade. We just wouldn’t do it because we don’t do individual names,” he said.

HSBC Securities (USA) Inc. is the agent.

The notes settled on Dec. 27.

The Cusip number is 40441XYP9.

The fee is 4%.

© 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.