HSBC’s $525,000 autocallable contingent income notes on stocks show attractive risk reward, entry

By Emma Trincal

New York, March 21 – HSBC USA Inc.’s $525,000 of autocallable contingent income barrier notes due March 18, 2025 linked to the common stocks of United Airlines Holdings, Inc. and American Airlines Group Inc. provide a reasonable risk-adjusted return due to a low barrier and low entry points, advisers said.

The notes will pay a contingent monthly coupon at an annualized rate of 18% if each stock closes at or above the coupon trigger level, 60% of its initial level, on the observation date for that month. Payments will include any previously unpaid coupons for prior months, according to a 424B2 filing with the Securities and Exchange Commission.

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

At maturity, if the notes are not called and the least-performing stock finishes at or above its 60% coupon trigger, the payout will be par plus the final coupon. If the least-performing stock declines by more than 40% but less than 50%, the payout will be par. If it declines by more than 50%, investors will lose 1% for each 1% decline from its initial level.

Good entry

“I actually like the notes even though I don’t use stocks for notes, and I tend to avoid worst-of,” said Carl Kunhardt, wealth adviser at Quest Capital Management.

“But looking at American Airlines and United, the pricing is compelling. You’re not buying overpriced securities.”

United Airlines closed at $38.24 on the trade date, or 38% off its 52-week high of April.

The share price of American Airlines was $15.57, or 40% lower than its peak of June, when the notes priced last week.

Better business model

A concern is the current price of oil, he said.

“Because the airlines are a big user of oil, they do feel the pain of rising oil prices even more than we do in a car,” he said.

“That said, a few positive things have happened since the pandemic.

“Today, when you fly, there are no empty seats. The airlines during the pandemic have upgraded their fleet and their aircrafts are much more fuel-efficient. The companies have cut costs, flying fewer airplanes. So, despite the unordinary impact of high fuel prices on airlines, they’re managing pretty well.”

Kunhardt said the term of the notes was long enough to limit the downside risk.

Three-year, three-month

“Right now, we have an energy crisis and a geopolitical crisis,” he said.

But the memory feature of the notes was helpful.

“Even if you miss a few coupons, you’re not penalized. You can get paid later. You can even get paid in three years,” he said.

“Within three years, the U.S. energy crisis will be resolved. Why? Because the administration is going to have to allow oil companies to start drilling again on U.S. soil. Oil is back to $115 a barrel. It’s not manageable. As a politician you don’t survive that.”

Three years was also “a long time” for a geopolitical crisis, he noted.

“The war in Ukraine will be over way before that.

“By the time the notes mature, it’s unlikely that either United or American will be under water. They certainly won’t be down 50%.”

But investors should probably not expect to see the notes mature.

“I don’t think you’ll pass the call. Both stocks are going to be up, maybe not by a lot, but you’ll get called in three months and the note will be gone. You’ll make 4.5%.

“It’s a short-term play but for 4.5% in today’s market, I’ll take it.

“The risk reward of this note is pretty attractive,” he said.

Memory and frequency

Jerry Verseput, president of Veripax Wealth Management, said he liked the notes, whose structure he compared to a product he bought for his clients.

“We did something similar but on auto stocks. It was also a three-year with a 50% barrier at maturity. Just like this one, both payment dates and autocalls are monthly and the call kicks in after three months,” he said.

He was referring to a note issued by Credit Suisse AG, London Branch and tied to the worst of Ford Motor Co., General Motors Co. and Tesla, Inc. The coupon pays 29% per year based on a 70% coupon barrier.

“Unlike the airlines deal, we don’t have the memory. But the coupon is much higher. Memory features are expensive. We’d rather have a higher coupon,” he said.

“Now Tesla may go up more than the coupon. But I’m happy if I can make 29% a year.”

He said that before the Russian invasion last month, the underlying priced $100 below the barrier on the coupon payment date. For this month, the price is “interestingly” $100 above it.

“Memory is guarding you against a spike in volatility, like the Russian invasion. But the feature is more important on quarterly payments than on monthly payments,” he said.

“You don’t want to miss an entire quarter. I like memory features, but you pay for it and it’s usually with a lower coupon.

“Again, I use them for quarterly payments rather than monthly. In general, I’d rather have the higher rate.”

Industry exposure

But Verseput had a positive view on the notes.

“If you’re bullish on the airlines, it’s a great note. It gives you 18% a year and takes away 50% of the downside risk. I like it very much,” he said.

The three-month call protection was a little too short, he added.

“It’d rather have six or 12 months. But that’s the way for the banks to price the notes. If you don’t allow them to price properly, they’re not going to give you the terms,” he said.

The timing of the notes was also an advantage.

“The stocks are both down right now. They’re not likely to be down another 50% from here,” he said.

This adviser said he is somewhat bullish on the airlines.

“With Covid starting to taper off, we’re opening up and there is still pent-up demand for travel. Russia is masking the recovery that we should be seeing. The market is more volatile. But that shouldn’t last for three years,” he said.

For clients seeking exposure to the airline industry, the investment may be appropriate.

“I could do the note for a very narrow slice of a portfolio. It is a little bit speculative, and you need to know the airline industry. The client would have to be sophisticated. But it’s a good note,” he said.

HSBC Securities (USA) Inc. is the agent.

The notes settled on Friday.

The Cusip number is 40439JJ63.

The fee is 3.5%.

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