HSBC, Morgan Stanley offer revcons on stock, indexes to meet demand for fixed income

By Emma Trincal

New York, June 30 – As most structured products investors are scrambling for yield via worst-of and volatile underliers, some are more inclined to get less return for a guaranteed income. In both cases, the cost of structuring income products involves certain tradeoffs in this low volatility environment, sources said.

Two recent deals illustrate some of the concessions investors need to make to get a fixed interest rate as opposed to a contingent coupon.

Tiny barrier

In the first one, the adopted solution is a thin barrier at maturity. The use of a single stock in a volatile sector helped generate more premium as well.

HSBC USA Inc. priced $16.5 million of 7.48% airbag autocallable yield notes due June 24, 2022 linked to the common stock of Intel Corp., according to a 424B2 filed with the Securities and Exchange Commission.

Interest will be payable monthly.

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

The payout at maturity will be par unless the final share price is less than the conversion price, 90% of the initial share price, in which case the payout will be a number of shares equal to $1,000 divided by the conversion price.

The agents are UBS Financial Services Inc. and UBS Investment Bank.

The fee is 1.5%.

Modest coupon

The second deal, slightly longer than the other, offered a stronger protection in the form of a 20% geared buffer but paid a 5% a year coupon rate payable semiannually.

Morgan Stanley Finance LLC’s $10.55 million fixed-income buffered autocallable securities due Dec. 27, 2022 are tied to the lesser performing of the Russell 2000 index and the Nasdaq-100 index.

On the positive side, the risk was mitigated with the use of two equity indexes, and the 0.375% fee was substantially lower than that of the other offering.

Morgan Stanley & Co. LLC is the agent.

Tall barrier

“A 5% guaranteed coupon with a 20% buffer seems pretty high. It’s almost too good to be true,” said a market participant about the Morgan Stanley notes.

He was surprised to see in the HSBC deal a 90% barrier.

“I know that barrier sizes are shrinking. I’ve seen 60% becoming 70% or 70% turning into 80% but I haven’t seen less unless there’s no protection at all.

Revcon evolution

“We see demand for guaranteed coupon, but pricing is not there,” he said.

The two offerings share some of the features of the old reverse convertible structure, which was the dominant product 10 years ago, he said.

“High fixed rate, volatile underlying stock and short maturity. Then those products became autocallable to add more yield. The newer version is the contingency of the coupon.”

Second observation

A structurer looked at the deals, repricing them both.

For the HSBC deal he was able to stretch the 7.48% coupon to 9.97% using JPMorgan’s funding rates. The fee could be lowered to 1.2% at this price, he said. The other terms would be the same, including the barrier level, which this structurer did not like.

“90% is far too low,” he said.

Faulty tradeoff

Getting a fixed coupon at the price of a minimum amount of downside protection was not a good tradeoff in his view.

“A contingent coupon is a much better formula,” he said.

“Even if you put the coupon at risk, you’ll be able to lower the strike to very attractive levels, which is going to hugely improve your risk return profile. A 90% barrier is hardly a downside protection. You’re better off lowering the barrier to boost your protection at the end while at the same time, increase the odds of getting paid or called.”

This structurer then attempted to reprice the Morgan Stanley deal.

“I’m using the S&P instead of the Russell and I get a lower coupon,” he said.

“The correlations are different. But just as a proxy, this deal is well-priced.”

The Cusip numbers for the HSBC and Morgan Stanley deals are 40439K821 and 61773FBF9, respectively.

The trade date for each deal was June 21.

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