Investors in HSBC’s $2.77 million autocall contingent coupon notes on ETFs prioritize defense

By Emma Trincal

New York, Aug. 2 – HSBC USA Inc.’s $2.77 million of autocallable contingent income barrier notes due Nov. 1, 2024 linked to the least performing of the Energy Select Sector SPDR fund and the SPDR S&P Oil & Gas Exploration & Production ETF offer a modest coupon, but for buyers seeking safety rather than yield enhancement, the trade may be worthwhile, advisers said.

Each month, the notes will pay a contingent coupon at an annual rate of 9.4% if each fund closes at or above its coupon trigger level, 60% of its initial level, on the observation date for that period, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par plus the contingent coupon if each fund closes at or above its initial level on any monthly coupon observation date after six months.

The payout at maturity will be par unless any fund closes below its 60% barrier value, in which case investors will lose 1% for each 1% decline in the least performing fund.

Defensive play

“The coupon is underwhelming,” an industry source said.

“We’ve seen these kinds of coupons when interest rates were low. You’re not getting much of a bump. I can see why it may not be appealing if you’re looking for yield.”

Some factors, however, explained the moderate contingent interest rate.

“Even though you’re taking equity risk, the two sectors are pretty correlated. In addition, volatility has been going down. So, you can’t stretch a coupon much higher,” he said.

The value of the note relied in its “very low” barriers,” he added.

“You get paid the coupon and you get your money back at maturity unless one of the ETFs drops more than 40%. A 40% drop, even on a 15-month period, that’s a lot.

“It’s a conservative note. People probably bought it for the low barriers and that’s why you can’t get a huge coupon,” he said.

Looking back

Competing rates from other securities could explain the small deal size.

“It may have been difficult to attract investors, especially when you can get more than 5% a year risk-free with cash or Treasuries,” he said.

Higher rates were available in the not-so-distant past, which deter some investors from buying newer issues.

“Some people are reluctant to get a 9% coupon when they were getting 12% last year,” he said.

But this approach was flawed, he said.

“People should make decisions based on current choices. Who knows what rates and equity returns will be six months or a year from now? Decisions to buy or not buy a note should be based on risk tolerance,” he said.

Mildly bullish bet on oil

A market participant agreed that the coupon was not very compelling for a worst-of payout with sector exposure.

“Correlations are extremely high between the two. You’re getting nearly 10% with a lot of downside protection.

“It’s not super exciting for a worst-of, but if you feel confident about oil, you should probably feel that the note provides enough safety,” he said.

Oil prices have fluctuated significantly since February 2022 when Russia invaded Ukraine, he said.

“For a while, especially in the months following the Russia/Ukraine situation, investors were bullish on oil expecting shortages would push prices higher. It has cooled off a little bit, but there is renewed interest in oil, at least we’ve seen this over the last couple of months.”

Both the amount of downside protection and the short tenor explained the low coupon, he said.

“You get a big cushion for that relatively short term, which is not going to give you a very high coupon,” he said.

“If it was a two- or three-year note, the rate would be higher because the further you go, the more time there is for things to change, the more uncertain you’re going to feel whatever your view may be. As a result, you get paid more.”

Big sector play

This market participant compared the note with a large offering, which priced last week. It was Morgan Stanley Finance LLC’s $75 million of one-year callable contingent income securities linked to Technology Select Sector index and Nasdaq-100 index.

Investors will receive a coupon of 9%, paid quarterly, if each underlying index closes at or above its 80% downside threshold on the related quarterly observation date. The securities may be called after six months at par on any quarterly call date. The principal repayment barrier at maturity is also 80%.

“With this one, we wouldn’t get a lot of interest. That space has run up so much this year, there’s been such a big recovery in tech. I don’t think the timing is best,” he said.

The two deals were somewhat comparable, he noted.

He pointed to the “similar” coupon levels, the short-term tenors, the six-month call protection and the high correlations between the two underliers in each note.

Lower vol. in tech

The major differences were the size of the respective barriers and the nature of the call feature, one being automatic, the other, discretionary, he said.

“You’re giving up some of the coupon, almost half a percent. It’s probably because volatility has dropped in the tech sector,” he said.

The implied volatility of the Nasdaq-100 index is 17%. Back in December, it was nearly 30%, he noted.

The implied volatility of the Energy Select Sector (ticker: “XLE”) is 20.4% and that of the SPDR S&P Oil & Gas Exploration & Production ETF (ticker: “XOP”) is 26%.

“It’s XOP that’s driving the terms a little bit better,” he said.

The lower implied volatility in tech explained in large part the lower coupon seen in the second offering.

“Percentage-wise, it makes a difference,” he said.

However, the 80% barrier levels (coupon and repayment) were a far cry from the 60% thresholds seen in the other note.

“You’re giving up some coupon, you’re only getting half of the downside amount and it’s an issuer call... This second offering is not nearly as attractive,” he said.

HSBC Securities (USA) Inc. is the agent for the first offering.

The notes (Cusip: 0447AFN9) settled on Tuesday.

The fee is 1.5%.

The agent for the second deal is Morgan Stanley & Co. LLC.

The notes (Cusip: 61775HNU7) settled on July 27.

The fee is 2.15%.

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