HSBC’s growth barrier autocallables linked to S&P 500 beg to differ with leverage, no cap

By Emma Trincal

New York, June 1 – HSBC USA Inc.’s 0% autocallable growth barrier notes due June 28, 2019 linked to the S&P 500 index offer an unusual autocallable structure that gives investors access to leverage at maturity in the absence of an early redemption. Market participants debated over how investors may or may not benefit from the call.

The observation date is expected to be June 28, 2017. The notes will be called on that date at par plus a call premium of at least 12.5% if the underlying index is equal to or greater than 110% of the initial level, according to an FWP filed with the Securities and Exchange Commission. Most autocalls are triggered when the underlying closes above its initial price, sources said.

If the notes are not called, the payout at maturity will be par plus 1.25 times the uncapped exposure to any index gain.

Investors will receive par if the index falls by up to 25% and will be fully exposed to any losses if the index finishes below the 75% barrier level.

Different

The structure differs from a classic autocallable in two ways: the strike price is above the initial price and the premium investors may collect upon the event may not offer a lot more than the index, a structurer said.

Another important difference was the use of leverage, which is not commonly applied to this type of structure.

“Most autocalls pay a coupon, a premium or a contingent coupon upon the call, and when not called, you get exposure to the downside only. This one gives you upside participation with leverage, which is very unusual,” he said.

Hidden cap

But investors should not assume that they are buying a simple uncapped leveraged product, he warned.

“Just because it’s uncapped at maturity doesn’t mean there is no cap. From a risk perspective if the index is up 10%, you’re capped at 12.5%. As long as they call you, they have the cap. It’s just the observation time that’s different from maturity,” this structurer said.

Because it takes a 10% index gain to earn 12.5%, the autocallable outcome is not particularly attractive compared to most similar notes, which give investors a coupon or a digital payout, he said. Very often, the autocall is triggered when the underlying is above its initial level, which increases the margin, in which case investors may beat the index, he explained.

Two ways

“In the call scenario, at best this one is going to give you 2.5% in excess return. It’s not a lot. You’re more likely to underperform than outperform the index,” he said.

Holding the notes until maturity appears to be the most desirable outcome and the most likely to occur in a range-bound market, he said.

“You get the best scenario at maturity only if the index is not up 10% a year from now. Will it happen? Will it not? Anything is possible,” he noted.

“What you can’t say is that you’re buying a three-year uncapped leveraged note. That’s not what this is about. This is really a way to cap your return up front.”

For this structurer, the risk-adjusted return of a capped product was still in place: limited upside if a call occurs and the risk of losing one’s entire principal.

Risk

“You are capped whether you like it or not, which means limited upside. Meanwhile, your downside exposure is unlimited once you breach the barrier,” he said.

While each sequence excludes the other – there is no downside risk when the notes are called and the principal is only at risk at maturity, which is the no-cap scenario – this structurer considered the risk-reward to be unbalanced.

“It doesn’t look too good to me. I’m fine as long as I’m not called. From a risk standpoint, I have a cap and I have all my money at risk,” he said.

Trade off

A market participant had a different view on the payout.

“This is a great deal,” he said.

“You’re giving up the participation if you get called, but that’s the nature of a call. And you get a 12.5% return on a one-year. Not bad.

“If it doesn’t get called, you still make money.

“No matter what the S&P does, I think you’re doing quite well.

“On a three-year, you can do much better on leverage. But the autocall is not a bad thing. Who wouldn’t want to get 12.5% after one year?”

For sure, the risk of missing upside returns if the notes are called is there.

“But people can always buy the stock market if they want. The problem with investors is ... they often think in terms of ‘what if I had not given this up.’ But you have to think in terms of risk-reward. If you’re going to get 1.25 times leverage, no cap on the upside and a 75% barrier, you should be able to tolerate the cap.”

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

HSBC Securities (USA) Inc. is the agent.

The notes will price on June 27 and settle on June 30.

The Cusip number is 40433UPA8.

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