HSBC’s income plus tied to five stocks with 1.5%-7.8% rate offer high/low structure, protection

By Emma Trincal

New York, April 5 – HSBC USA Inc. ‘s income plus notes due April 26, 2024 linked to five common stocks offer investors some fixed-income attributes such as a fixed rate and principal-protection. But they may earn a higher rate based on market performance, according to an FWP filing with the Securities and Exchange Commission.

The underlying companies are Bristol-Myers Squibb Co., General Motors Co., HP Inc., Altria Group, Inc. and AT&T Inc.

The coupon will be 1.5%, the minimum rate, plus an additional coupon of 6.3% if each basket stock closes at or above its initial level on the valuation date for that year. Interest is payable annually.

The payout at maturity will be par.

Fixed-income

This type of payout is called a high/low coupon product, an industry source said.

Investors buying the notes want stable income first and hopefully more.

“At least you get 1.5% regardless and your principal is protected,” he said.

Investors can get an extra 6.3% return based on the market performance.

“You would to be bullish on those five stocks otherwise you take the risk of having the low coupon for a while, in theory for seven years,” he said.

Worst-of like

The products illustrated another use of the worst-of payout, he noted.

“All five stocks have to be above their initial price. It’s a digital on the worst performer. If it is at or above its initial price, you get the additional 6%.”

The five different stocks were likely to show a low or even negative correlation since they belong to five distinct industries, he said. Those are pharmaceuticals, automobiles, computers, tobacco and telecommunications.

“The low correlation should give you more premium since it increases the chances of one stock going down,” he said.

Pricing

This source examined the basics of the structure and pricing.

The credit spread for HSBC over seven years was 90 bps and the swap rate for that period, 2.2%.

Overall, the issuer has the sum of the two, or 3.10% to put to work.

“They’re giving you 1.5% so you have 1.6% to play with.

“They’re selling you for 1.6% a digital option on the least performer of the five names that can give you 6%.

“You spend 1.6% to get 6%.”

The principal-protection was obtained from a longer-dated zero coupon bond.

“Look it’s a reasonable deal. For someone who is bullish on those stocks, it gives you a chance to get a pretty high coupon,” he said.

“I’m sure it’s a fair deal. It depends on who is using it and for what purpose.”

Mostly CDs

A market participant said he saw this type of low/high coupon structure but in the form of market-linked certificates of deposit.

“By putting it in a note, you’re adding the credit risk. That way you can raise the fixed rate a little bit and also get a higher booster than what you would get with a CD,” the market participant said.

A similar CD may only offer a 1% minimum rate instead of 1.5% and a 5% booster in place of 6.3%, he said, saying that his example was “completely hypothetical.”

Despite the enhanced terms provided by the note wrapper, this market participant was not convinced that the deal would be the best option for income investors in today’s market conditions.

“Personally I wouldn’t invest in this. If you think that the market has made a big run and that we may be going sideways you run the risk of making only 1.5%.

“I’d rather do a seven-year worst-of index-linked with a 70% coupon barrier. I get a pretty good range to collect the coupon and I can probably get somewhere around 7%.”

One of the dangers with principal-protection, he said, is that investors tend to overlook other risks.

“Getting only 1.5% a year for seven years can be a real issue, especially in a rising rate environment,” he said.

Two equity indexes are more likely to close above a 70% barrier than five uncorrelated stocks to be above their initial price, he said.

“Yes my worst-of may put my principal at risk. But typically when you go as far as seven years you get a European barrier of 50%. Breaching that type of barrier is not easy. Look at any seven-year rolling period for an index, it’s never been down by 50%.”

A European barrier is one that is observed point to point at maturity and not during the life of the notes.

“Investors who want full downside protection at any cost are short-sighted. They’re accepting terms, which in the current interest rate environment are not attractive,” he said.

HSBC Securities (USA) Inc. is the agent.

The notes will price on April 25.

The Cusip number is 40433U2B1.

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