HSBC’s $760,000 autocallable barrier notes on stocks show disappointing risk-adjusted return

By Emma Trincal

New York, May 6 – HSBC USA Inc. priced $760,000 of 0% autocallable barrier notes with step-up premium due May 6, 2024 linked to the least performing of the stocks of Delta Air Lines, Inc., Zoom Video Communications, Inc. and Citigroup Inc., according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par plus a call premium if each stock closes at or above 87% of its initial level on any quarterly observation date. The premium is 18% per year.

If the notes are not called, meaning all stocks have finished below 87% of their initial levels, the payout will be par unless any stock has finished below its 65% barrier level, in which case investors will lose 1% for each 1% decline of the least-performing stock from its initial level.

Three stocks

“It seems like a reasonable bet. I don’t see a lot of downside risk there,” said Lance Roberts, chief investment strategist at Clarity Financial.

But Roberts was not in favor of the risk reward, saying that there was a possible opportunity cost associated to the trade.

“Zoom is under a lot of pressure. Citi could get hit if we go back to curve flattening mode,” he said.

Delta Air Lines was also in a vulnerable spot.

“The stock has already run up a lot. When the stimulus money dries up, they’ll still have to pay the same wage after the huge amount of revenues they lost during the pandemic. People will probably make one trip a year then go home. I don’t know if it will be enough to get them back to where they were prior to Covid,” he said.

Attractive terms

Yet the structure of the notes made for a possible good play at least for investors who are bullish on the economy.

“If you believe in the reopening story, it’s very reasonable. I don’t really think any of those stocks could drop more than 35% three years from now,” he said.

“Besides, chances are you’ll get called early on.”

The structure offers a lower call threshold at 87%, which may make it more likely to trigger the automatic call than when the strike is at initial price level, he also noted.

“You can get paid after three or six months. You may not have to hold the notes for three years,” he said.

Another positive feature was the cumulative nature of the premium, he noted.

May yield nothing

Despite those positive items, Roberts said he would probably not buy the notes.

“It’s such a convoluted structure. It’s too hard to explain,” he said.

More importantly, Roberts said the market outlook was worrisome.

“The markets are extremely overbought overall. Even though I don’t think you get a lot of risk at maturity with this note, especially with that 35% protection, you still run the risk of just getting your money back after three years with no return. That’s not a good risk-reward. You come out better buying a 10-year [Treasury] at 1.5% or 2%.”

Not right now

Roberts expects a “big correction” in the equity market. The bull market has expanded for a long time and valuations have reached significantly high levels, making a decline in asset prices almost necessary to revert the cycle.

Many factors could trigger the reversal. The adviser pointed to inflation as a likely one.

“I’m looking at a very strong surge of inflation in the next month or two,” he said.

But Roberts expects inflation to be short-lived followed rapidly by its opposite pattern.

“Inflation is always transitory. When prices rise, people spend less. As consumption slows down, so does the economy of course.”

The timing of the notes was not advantageous.

“The concern I have about taking big bets on equity at this time is that we’re about to have a big correction,” he said.

“It’s not a bad note. But I don’t think this is the right time.”

Rich stocks

A financial analyst also objected to the timing and risk-adjusted return of the notes.

“It’s a crazy combination of stocks. You have a chance of losing money on all three, especially on a three-year. They’re all overvalued,” he said.

This analyst sees a series of market corrections through 2023, which could be substantial enough to increase the odds of at least one of the three stocks falling below the barrier level in 2024.

“Citigroup like all banks may benefit from higher rates. But rates may not be up,” he said.

With a price-per-earnings ratio of 10, the stock was “not nearly as overpriced as Apple,” he said.

Yet, the share price nearly doubled since a bottom in March 2020 to its recent 52-week high on March 18, he added.

Zoom offered better prospects.

“At least this is one of the weakest. It has gone down by half since October. The P/E is at 139 but was at over 300 in October. Earnings have improved but this is another example of a stock that is still high because we’re in an overall bubble. Prices don’t make any sense. I see it going below 100,” he said.

All over the sector map

Another problem with the underlying was the correlations between the stocks, each of which belongs to distinct sectors – industrials, technology and financials.

While Citigroup and Delta showed a 0.83 coefficient of correlation to one another, Zoom and Delta as well as Zoom and Citigroup had slightly negative correlations.

Since the exposure is not to a single asset but to the worst of three stocks, the lower the correlations, the greater the risk of at least one of the three falling.

“You have three very different kinds of stocks. The 13% call trigger can easily be breached, so you may not even get paid. Granted you can make up the lost premium at a later date. But if you don’t get this call, you can easily lose money at the end. If we have a very bad correction, you’re not going to have enough time to recover. One of those three stocks could end up down more than 35%,” he said.

“It’s not a good enough value to take that risk.”

HSBC Securities (USA) Inc. is the agent.

The notes settled on Thursday.

The Cusip number is 40439JAK1.

The fee is 4%.

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