HSBC’s leveraged notes with call feature on oil stocks show appealing terms in tough industry

By Emma Trincal

New York, May 20 – HSBC USA Inc.’s 0% barrier participation notes due May 25, 2022, linked to the least performing of the stocks of Chevron Corp., Marathon Petroleum Corp. and Valero Energy Corp. offer compelling pricing, advisers said, perhaps in part due to risk associated with the oil industry.

The notes will be called at par plus a call premium if each stock closes at or above its call threshold, 110% of its initial price, according to an FWP filing with the Securities and Exchange Commission.

The call premium, which will be set at pricing, will be at least 40%.

If the notes are not called and each stock finishes at or above its initial level, the payout at maturity will be par plus 2x the return of the least performing stock.

If any stock falls but each stock finishes at or above its 50% barrier level, the payout will be par.

Otherwise, investors will be fully exposed to the decline of the worst performing stock.

Barrier

“The 50% barrier is pretty hefty. The terms are quite good. It’s just a matter of doing your due diligence and see if you’re comfortable with the underlying stocks,” said Steve Doucette, financial adviser at Proctor Financial.

“But still. 50% is pretty solid. I don’t think any of those stocks could fall that much three years from now.”

One headwind for those oil companies is the transformation of the energy industry into a more environmentally focused sector. The current administration vowed to achieve net zero emissions by 2050.

Wildcard

“The push toward clean energy is real. That’s the direction we’re heading to,” he said.

“Hopefully within the next three years, those three companies will have already begun to adjust and restructure themselves, diversifying their operations into renewable sources of energy,” he said.

“If I had to buy this note, I would examine each stock and find out if they’re the best positioned for this transformation.”

Risk-adjusted return

The main concern for this adviser was the exposure to company-specific risk, to which investors in single stocks are always confronted.

“As an asset allocator, we prefer broader indexes or ETFs. But where else are you going to get those terms without taking on some business risk?” he said.

As an exception, this adviser would consider the notes despite the single stock underliers because of the attractive structure.

“If the stocks are up 10% after one year, you get this unbelievable coupon. With a 40% return in one year, even if the market is already up by at least 10%, you’ll outperform,” he said.

“If everything gets ugly in the oil industry, chances are you’ll outperform on the downside too. Three years out with a 50% protection, you should be OK.

The upside scenario in the absence of a call was also appealing.

“If it’s up, you’re also going to outperform with 2x leverage and no cap,” he said.

Winning bands

Doucette said he particularly liked what he called the “ranges” of outperformance.

The 50% downside protection allows for a wide range of decline, he noted. The 40% call premium is well above the call threshold of 10%, allowing here again for a significant outperformance. Finally, the uncapped leveraged upside by definition has “no boundaries,” he noted.

“You just have to research the three companies and figure out if they’re innovative enough to be able to adjust to this new green world. If they’re not the best stocks, you may have to replace them with better ones even if it means giving up some of the ranges,” he said.

“There’s the correlation risk too. It’s a worst-of. If one stock collapses, you’ll underperform.”

Too good to pass

Doucette said that such terms could never be matched with an index or fund as the underlier. Also, a worst-of payout was probably unavoidable for pricing.

He would be open to overlooking the “company” risk associated with single stocks given the appeal of the structure.

“I would still do my due diligence on the stocks to make sure I’m comfortable.

“But that’s a heck of a note.

“40% coupon, 2 times leverage uncapped, 50% barrier. You just don’t get those terms anywhere in structured products nowadays unless you take some company risk,” he said.

Sector challenge

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said the embedded oil theme was timely.

“I like the notes. The stocks are in an interesting sector right now. The oil industry is going through a lot of changes. I expect that a year from now we should be able to build up reserves which would be favorable for the stocks. That would increase the odds of being called in one year with the 40% premium,” he said.

The Administration’s commitment to new renewable energy however is a “wildcard” for the oil industry, he said.

Growth ahead

Recent fuel shortages have pushed up oil prices, leading investors to worry about the possibility of more supply disruptions in the future.

“If gasoline prices spike up especially this summer, the government may feel some pressure from its constituents.

“People may realize that it takes time to replace oil by clean energy. This might be an incentive for those oil companies to start building up reserves.

“At least for the next year, I see growth potential for those oil stocks.

“Even the 110% trigger for the call doesn’t seem far-stretched. Not in this environment. You should get called in one year.

“If not, the 50% barrier is deep enough to protect you.

“I like the note.”

HSBC Securities (USA) Inc. is the agent.

The notes were set to price on Thursday and will settle on Tuesday.

The Cusip number is 40428HQH8.

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