HSBC’s $4.91 million autocalls on indexes include lesser-used FTSE 100

By Emma Trincal

New York, Jan. 30 – HSBC USA Inc.’s $4.91 million of 0% autocallable barrier notes with step-up premium due Jan. 24, 2029 linked to the least performing of the Russell 2000 index and FTSE 100 index present a not-so-common exposure to the U.K. stock market via its benchmark used in a worst-of payout.

The notes will be called automatically starting on April 19, 2024 if the level of the worst performing index is greater than or equal to its initial level and on any subsequent quarterly observation date at a premium of 10.35% per year, according to a 424B2 filing with the Securities and Exchange Commission.

The maturity date premium is 51.75%.

If the notes are not called, the payout at maturity will be par if the worst performing index finishes at or above its 75% barrier. Investors will lose 1% for every 1% that the worst performing index declines if it finishes below the barrier level.

Rarely used

“We don’t usually see the FTSE in notes. It’s probably because we don’t do many country-specific notes,” said Brady Beals, Luma Financial Technologies director, sales and product origination.

“For instance, we don’t trade a lot of SMI. There was a time when SMI was more in vogue.”

The SMI is the Swiss stock market index.

“In general, the international exposure is achieved through the EAFE or the Emerging Markets indices,” he said.

Only one deal tied to the FTSE 100 index alone priced last year, according to data compiled by Prospect News. It was a JPMorgan Chase Financial Co. LLC’s $1.16 million issue of five-year uncapped digital notes sold in November. There was only one deal using the same pair of indexes in a worst-of (FTSE 100 and Russell), which priced last year. It was a $6.93 million offering of autocallables issued by UBS AG, London Branch in June.

Low correlation

Issuers tend to pick non-correlated underliers to offer better pricing when structuring worst-of notes.

The use of the Russell 2000 index, which represents the small-cap segment of the U.S. equity market, in conjunction with the FTSE 100, which tracks the 100 largest U.K. companies, will generate some premium due to the disparity between the two underliers.

“There is a low correlation between the two,” Beals said. Those are the result of geographic and market capitalization differences, he added.

The five-year coefficient of correlation between the Russell 2000 and the FTSE 100 is only 0.75.

In comparison, two U.S. benchmarks with different market capitalization sizes – the S&P 500 and the Russell 2000, have a 0.88 coefficient of correlation.

Two large-cap indexes in different geographic regions – the S&P 500 and the FTSE 100 – show a 0.81 correlation.

Macro views

The Russell 200 represents a strategic view on growth, Beals noted.

“With the Russell, you’re making a bet on the economy. You expect small caps to perform well in a soft-landing environment,” he said.

“The FTSE since Brexit I suppose is less correlated to Europe. The assumption perhaps is that it’s going to grow stronger than expected.”

Getting exposure to the U.K. markets could also be a sector play reflecting a bullish bet on banks, he noted.

“There is a financial bias in this index,” he said.

The financial sector has the top sector allocation in the index, with a weighting of nearly 19%.

But the structure offered nothing particularly unusual, he said.

“The five-year maturity is OK.

“You would get a similar structure for U.S. indices, I guess the Russell and the Dow.

“Nothing to write home about when it comes to the structure of this note,” he said.

Global allocation

A market participant also expressed surprise at the use of the FTSE 100 index.

“It’s interesting. The FTSE – we don’t see a whole lot of that,” he said.

“The U.K. is not part of the Euro Stoxx. I guess it gives you international exposure in a different way than the typical use of the MSCI indices. It helps you diversify away from the Euro Stoxx 50 or the EAFE. Those are the international ones that we see most often.”

One-year no-call

The 75% barrier size over five years made the notes relatively defensive.

“I wouldn’t mind a 75% or 80% barrier on a snowball. It’s quite reasonable,” he said.

Snowballs are autocallable notes which pay a cumulative premium when called.

One downside of the structure was the timing of the first quarterly call set for April.

“I would want to see a one-year no-call because with the quarterly autocall, you get hit with short-term capital gains,” he said.

Investors may not mind the tax treatment in a non-taxable account, he said. But he stressed his preference for the one-year call protection.

The call premium in a snowball, since paid upon early redemption is typically subject to capital gains or losses. Extending the first call to a period of more than one year allows the profit to be treated as long-term capital gains versus the less advantageous short-term tax treatment, he explained.

Conservative structure

A quarterly call makes the barrier breach less likely, he noted.

“You have 20 chances of getting called. It’s a five-year paper. But with quarterly calls and no no-call, you’re unlikely to have a five-year duration,” he said.

“In that sense, the 75% barrier may be a little bit overkill.”

Reducing the size of the barrier could be beneficial.

“I’d rather pick up a little bit of funding by raising the barrier. In exchange I could get a higher premium, but more significant for me, I’d get a one-year no call. Another way to reduce the likelihood of a call is to raise the call threshold, make it 105 instead of 100,” he said.

“Overall, it’s a pretty safe note. You have a five-year autocall with a 75% barrier and you still get a double-digit return. It’s not bad.”

The notes settled on Jan. 24.

The Cusip number is 40447AWW0.

The agent is HSBC Securities (USA) Inc.

The fee is 2.85%.

© 2015 Prospect News.
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