Call, election spotted as risks with HSBC’s contingent income autocalls tied to bank stocks

By Emma Trincal

New York, May 18 – The terms of HSBC USA Inc.’s autocallable contingent income barrier notes due Nov. 28, 2022 linked to the least performing of the common stocks of JPMorgan Chase & Co., Wells Fargo & Co. and Goldman Sachs Group, Inc. are attractive, advisers said. But the risk would not warrant investing in the product due to the chances of an early automatic call, said one adviser. The other buysider stressed the vulnerability of the underlying stocks, which, he believed are highly exposed to political risk.

Each quarter, the notes will pay a contingent coupon at an annual rate of 16% if each stock closes at or above its coupon trigger price, 60% of the initial share price, on the observation date for that quarter.

The notes will be called at par plus the contingent coupon if each stock closes at or above its initial share price on any quarterly observation date.

If the notes are not called, the payout at maturity will be par unless any stock finishes below its 60% trigger level, in which case investors will be fully exposed to the decline of the least performing stock.

Attractive but too short

Carl Kunhardt, wealth adviser at Quest Capital Management, expressed concerns about the autocallable feature.

“I wouldn’t waste time on it,” he said.

“I don’t like sector funds; I don’t like sector notes. I really don’t like worst-of. Most likely the worst-of is going to be Wells Fargo here. It’s the weakest of the three.”

But these were not the factors leading him to show little enthusiasm for the notes.

“They created a very attractive product. There is really not a lot to dislike. The terms are great,” he said.

“But the chances of getting passed the first quarter are slim.

“So it doesn’t matter how attractive a note is if you’re only going to hold it for three months.”

Investors if called on the first call date would pocket 4%.

“It’s still a 16% per year. But I’m only getting a quarter of that. Not worth my time.

“It’s like running on a treadmill, putting on a lot of energy and not going anywhere,” he said.

Not three apples

The three bank stocks at first appeared like a cohesive group within the banking sector, which is always a positive in a worst-of as it increases correlations between the underlying assets. But Kunhardt saw it differently.

“Goldman is not really a bank. It’s an investment bank,” he said.

“What you have here is not three apples. It’s two apples and one pear.

“Goldman is definitely not offering the full banking services of a JPMorgan.

“I really don’t see them as a bank. It’s another animal.”

Finally, the 4% fee for the two-and-a-half year holding period appeared expensive, especially if the notes are called early.

“In this day and age, paying 400 basis points when you can get an ETF for 4 bps doesn’t make much sense to me,” he said.

Happy with the yield

Jerry Verseput, president of Veripax Wealth Management, did not balk at the reinvestment risk.

“I like the three stocks. It’s a bet on the banking sector and that’s fine,” he said.

“I wouldn’t use it for income because it can be called. You can look at it as growth or as income. It’s really a 16% total return note. I’m happy with 16% annualized. I simply wouldn’t build it into an income plan.”

His concern was how bank stocks may be exposed to political risk ahead of the U.S. presidential elections in November.

Warren and Wall Street

“[Joe] Biden is likely to choose [senator] Elizabeth Warren as his running mate, and she is very aggressively against the big banks,” he said.

“When Biden announces his choice, if she’s his pick, I can see the U.S. banking sector drop significantly. She’s been very vocal against Wall Street. She wants to break up the big bank, reinstate regulation.”

Naturally, investors may get called in three months, which would eliminate all risk. But the automatic call event may not happen so easily. The first call date, on Aug. 25, falls at the time of the National Democratic Convention set for Aug. 17-20.

“If he hasn’t done it by then, he will have to announce who his running mate is at the convention,” he said.

“You have plenty of political risk there because the performance of the notes depends on what happens to the big banks. And the banks perceive Warren as a threat.

“It’s a very real risk, and I’m not sure 16% compensates you for it.

“One of those banks could easily go down 40% in two and a half years if she becomes the vice-president of the United States.”

Verseput said he just would not get exposure to the banking sector at this time.

“I would look at a note like that later in the summer, once we know who the running mate is,” he said.

Another deal

The pricing of the notes was fine, especially the 16% coupon. But less than two months ago, Verseput said he purchased a better-priced deal based on less risky underliers, which pays a higher coupon.

“It was right at the bottom of the market when volatility was spiking,” he said.

“We bought a one-year Citi note on the S&P, Russell 2000 and the Dow. It also had a 60% coupon barrier and a 60% at maturity. It was autocallable after three months. But the coupon was 19% payable monthly,” he said.

Rates are in

Investors often stress low interest rates as a key risk when investing in bank stocks. Verseput did not share this view.

“The low interest rate issue is already baked in,” he said.

Such was not the case with the risk associated with the upcoming elections.

“It’s too soon to get exposure to banks. It hasn’t priced in yet.

“Coming into November, I will carry a large cash position. It’s a riskier time so why not take some chips off the table then?”

Verseput did not mind the 4% fee.

“As long as you’re happy with the 16%, it doesn’t really matter,” he said.

But a lower fee could certainly make room for better terms.

“If you do customized notes you might negotiate the fee and get better terms. That’s why I like to do them.”

HSBC Securities (USA) Inc. is the agent.

The notes will price on May 22.

The Cusip number is 40438CHP9.

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