HSBC’s contingent income notes tied to Russell 2000, S&P 500 have long call protection period

By Emma Trincal

New York, Nov. 30 – HSBC USA Inc.’s contingent income autocallable securities due Dec. 14, 2026 linked to the worse performing of the Russell 2000 index and the S&P 500 index have all the normal attributes of most autocallable worst-of contingent coupon notes except for the length of the no-call period, which is five years, or half of the stated tenor, sources noted.

Each month, the notes will pay a contingent coupon if each index closes at or above its coupon barrier level, 60% of its initial level, on the determination date for that month. The contingent interest rate is expected to be at least 7.13% per year and will be set at pricing, according to an FWP filed with the Securities and Exchange Commission.

Five years of protection

The notes will be automatically called at par of $10 plus the contingent coupon if each index closes at or above its initial level on Dec. 9, 2021, Dec. 9, 2022, Dec. 11, 2023, Dec. 9, 2024 or Dec. 9, 2025.

If each index finishes at or above its downside threshold level, 50% of its initial level, the payout at maturity will be par plus the final contingent coupon, if applicable. If the final level of either index is less than its downside threshold level, investors will lose 1% for each 1% decline of the lesser-performing index.

Getting more for longer

An industry source said the term of the notes is unusually long for a worst of. But he reasoned that the five-year no-call period is beneficial to investors and that extending the duration was a pricing necessity in order to make the product work.

“First, you have the S&P and the Russell. Surprise, surprise ... Nothing unusual here, but those two are fairly correlated, which represents less risk,” this source said.

“The coupon barrier is low, so you have a reasonable chance to get your coupon. Without any call protection, you could get called after one year at 7%. Some investors may not like it. With the five year no-call, you get a decent return for five years.”

Pricing

Many similar structures will offer a three- to five-year tenor with one year of call protection, he said.

“You never see 18-month with a one-year no-call. The callability is part of the pricing. It’s what is supposed to give you a better yield.”

Notes that are either callable or autocallable carry a level of uncertainty since investors do not know ahead of time how long their investment will last. Upon early redemption, investors incur some reinvestment risk as they may not find equivalent or higher yields in the market.

“This five-year no-call reduces some of the risk. Given the barrier, it also gives you a pretty good chance to get a decent return over that period. This is why they had to extend the maturity beyond the five-year call protection. Otherwise the structure was not going to work.

“As it is, pricing looks fair to me.”

Low reinvestment risk

A market participant was skeptical about the benefit of the long call protection period in the current interest rate environment.

“Rates are moving up. More people think we’ve turned the corner on interest rates. A lot believe that higher rates mean lower equity prices. I question that. You have to look at why interest rates are going up in the first place. Right now both rates and equities are moving in the same direction for the same reason. ... The prospect of growth has a chance to accelerate. Stock prices are up, and yields are up,” he said.

In such environment, an early redemption may benefit investors more than it may hurt them.

“You’re likely to replace that coupon with a higher coupon in the short term. The extended call protection may not necessarily help you get a higher coupon,” he said.

One-year no-call

This market participant said he has recently structured 10-year worst-of contingent coupon deals linked to the same pair of indexes. The principal difference was that such products had non-callable periods of one year instead of five. The coupon barrier was at about 70%, and the barrier at maturity was at 50% as with the HSBC notes. The contingent coupon was between 7% and 8%, depending on the issuer.

“On the face, the 7% handle looks pretty standard,” he said.

The barrier levels and underliers are comparable.

The main difference is the extended call protection.

“We usually do one year, not five, and I think it’s to the benefit of the investor since rates are going up, not down.”

HSBC Securities (USA) Inc. is the agent. Distribution is through Morgan Stanley Wealth Management.

The notes (Cusip: 40433UA48) will price on Dec. 9 and settle on Dec. 14.

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