HSBC’s growth barrier notes linked to S&P 500 offer autocall combined with uncapped leverage

By Emma Trincal

New York, March 1 – HSBC USA Inc.’s 0% autocallable growth barrier notes due April 1, 2019 linked to the S&P 500 index offer attractive upside potential and downside protection when the notes are not called and mature, sources said.

Even if a call is triggered, which can only happen once, the premium offered is likely to satisfy a wide range of investors even though the chances of outperforming the index in this scenario are limited, they noted.

The notes will be automatically called at par plus at least 13.5% if the index closes above the 110% call level on March 29, 2017, according to an FWP filing with the Securities and Exchange Commission.

The payout at maturity will be par plus at least 135% of any index gain. Investors will receive par if the index falls by up to 25% and will be fully exposed to losses if the index finishes below the 75% barrier level.

Good barrier

Tom Balcom, founder of 1650 Wealth Management, preferred the payout at maturity rather than receiving the call premium.

“I’m not sure why they have the autocall. If the index after one year is up 11%, you’re out and you make 13.5%. Good. But if it’s up 14% or 20%, you’re capped at 13.5%. That’s the risk on the upside even if the cap is pretty high. You only outperform if the index return stays between 10% and 13.5%,” said Balcom.

The call premium, in other words, is not a good payout for bulls, he said, as they would miss any market gain above 13.5%.

However, other types of clients are likely to like the structure.

“If you’re worried about the downside, you get a 25% barrier. That’s pretty good,” he said.

“I like what happens if there is no call. You have a lot of protection. And you have 1.35 times with no cap.”

Balcom said he has “no idea” why the issuer introduced the autocall option or whether it was designed to facilitate pricing, such as the elimination of a cap at maturity.

He would prefer a similar structure without the automatic call feature.

Too short

“If you get called, it’s pretty good. Having 13.5% on a one-year definitely exceeds what you can get on a bond. So it’s not so much the cap that’s a problem for me. My real issue is the term. We just don’t invest very short term, and one year is short term,” he said.

“I’d rather remove the autocall and get less leverage. Or I wouldn’t mind having a cap with two times leverage if I can keep the notes as a three-year with no call.”

Donald McCoy, financial adviser at Planners Financial Services, said he likes the structure as it is.

“This is interesting. It has a lot of upside to it. There is so much upside and a significant barrier. Twenty-five percent over a three-year timeframe is pretty significant,” he said.

Not for permabulls

For McCoy, the autocallable feature would only be problematic for a very bullish investor.

But such bullish expectations are becoming rare in today’s market.

“If you’re concerned of being capped 13.5% a year, I would think your expectations are not terribly realistic,” he said.

“Let’s say you are that type of bull, then you just won’t buy this note. If you think the market will gain 20% in the next year, you’re not going to get into this thing in the first place. Why cap yourself if you believe the market is about to take off like a rocket?”

The notes, however, are likely to appeal to a great number of investors who anticipate more muted market returns, he said.

Slow growth

“If you think it’s going to muddle around with returns somewhere around 5% or 6%, then one you don’t get called [and] two you get the uncapped upside with that kicker, which will more than make up for the loss of dividends,” he said.

He was referring to the 1.35 leverage factor.

“In addition, you’ve got the 25% barrier, so if the market is down 25% you’re whole.”

Usually autocallable products do not incorporate leverage, he noted, which makes the notes relatively unique.

In general, autocallable notes deliver a call premium, coupon or contingent coupon but no appreciation.

“The fact that they put this autocall after one year is the part that really fascinates me,” he said.

“The issuer probably doesn’t think the market is going to be strong the next year.

“For the investor, the autocall is actually a pretty good outcome. You get 13.5%, which is a significant amount of return over one year.”

Such outcome, however, is unlikely to happen in his view as it requires at least 10% of index growth.

“My expectation is in the mid-single digits for the next 12 months. If the market surprises you, you get 13.5%. I don’t see many people complaining about that.”

The structure could be attractive for a variety of clients, he explained.

“But not for the super bullish,” he said.

“It works for people like me who have moderate expectations about the market. Even if you’re bullish, it works because the probability of getting called and missing on a lot of return above 13.5% is small, so you have a good chance to do well after three years with the leverage and no cap.

“And for a conservative investor, the 25% protection is very appealing.

“I like it.”

HSBC Securities (USA) Inc. is the agent.

The notes will price on March 28 and settle on March 31.

The exact deal terms, including call premium and upside participation rate, will be set at pricing.

The Cusip number is 40433UJN7.

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