HSBC’s $263,000 autocalls on index, ETF offer longer term cumulative premium

By Emma Trincal

New York, Jan. 27 – HSBC USA Inc.’s $263,000 of 0% autocallable barrier notes with step-up premium due Jan. 26, 2026 linked to the lesser performing of the iShares MSCI Emerging Markets ETF and the Russell 2000 index offer an annual call option paying nearly 10% annually in cumulative premium, but the conditions for the payment are harder to meet than with the typical autocallable contingent coupon notes.

If each underlier closes at or above its initial level on any annual valuation date, the notes will be called at par plus an annualized call premium of 9.5%, according to a 424B2 filing with the Securities and Exchange Commission.

If each underlier finishes at or above its initial level, the payout at maturity will be par plus 38%, the premium applicable to the final valuation date.

If the notes are not called, the payout will be par unless any underlier has finished below its 70% barrier level, in which case investors will lose 1% for each 1% decline of the least-performing underlier from its initial level.

Snowball

“These snowballs are interesting. You get called and you collect your 9.5% coupon. If we’re in a bear market, you just let it ride,” said Steve Doucette, financial adviser at Proctor Financial.

The term snowball is often used to designate a note that pays a call premium as opposed to a coupon. There cannot be any payment unless the notes are called. Once the call occurs, however, a memory feature allows investors to capture previously unpaid premium.

For Doucette, the market risk at maturity was not essential.

“This 70% barrier is pretty secure,” he said.

The greater risk was the absence of a call or the delayed payment.

“Despite the cumulative payments and the protection at maturity, you still run the risk of not getting paid,” he said.

He compared the notes’ payoff with that of the typical contingent coupon autocallable, often named “Phoenix.”

No call, no payout

“Normally you get paid a coupon above a barrier. The index is down but it’s still above a 70% barrier. You collect, and you can collect again and again while you still hold the note. I sort of like that. I see those contingent coupons as some kind of buffers you can capture along the way,” he said.

The snowball typically pays a higher return with its call premium simply because the payout threshold – at 100% versus 70% for instance – is a higher hurdle, he noted.

“The worst-case scenario with that snowball is if you don’t get called. You’ve been holding the notes for four years without collecting anything, not even one payment,” he said.

Doucette stressed that while investors often point to “call risk” or “reinvestment risk,” there is also a risk in the absence of a call.

“Some weird things can happen. We have a couple of [callable] notes and the issuer didn’t call,” he said.

Best structure

For this adviser, the ideal structure would be a Phoenix contingent coupon autocallable with a memory feature.

“As you collect the coupon, you build up a little cushion. And if you miss a payment, you capture it later. That would be kind of neat,” he said. “Would I get 9.5% per year? Maybe not. I just wonder how much coupon I would have to give up in order to get that type of feature.”

Doucette stressed what he perceived as the greatest risk of the note.

“As an adviser, we’re positioning these products as income substitutes. I’d rather give up some yield and make sure I get some coupon during the term. Your coupon is at risk and that’s what you need to keep in mind,” he said.

Mixed bag

Another negative was the use of two uncorrelated assets in the worst-of.

“I would have to look at them both and do my due diligence. Obviously, they’re probably not highly correlated,” he said.

The coefficient of correlation between the two is 0.78. In comparison, the S&P 500 index and the Dow Jones industrial average showed a coefficient of 0.98.

Putting those two assets together in a worst-of also represented a “lost opportunity,” he said.

“Emerging markets valuations are much more reasonable than anything in the U.S., even small-caps. And you’re not going to get it.”

Finally using the two underliers in a worst-of could be problematic for an asset allocator.

“We wouldn’t blend international and U.S. in a note. Where do you put it? You can’t divide it up in two pieces, one U.S., one non-U.S. We tend to avoid that,” he said.

Future returns

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said he liked the notes.

“It’s an interesting deal. Returns should be much more modest than in the previous years. Depending on the asset class, mid to high-single digits are most likely,” he said.

“I usually don’t like caps on equities. But this 9.5% per year, given our return expectations, is an acceptable cap.”

Defensive play

Medeiros also liked the four-year maturity.

“The tenor is good. Since it’s a longer-term note, I believe the barrier is sufficient. There is a greater opportunity to get through the next business cycle when your duration is long enough,” he said.

“Right now, with 4% intraday moves in the market, I wouldn’t be comfortable with a shorter-dated note. But four-year is fine.”

Overall, the note was relatively defensive, which made it opportunistic in the current market environment, he said.

Medeiros said the choice of the two underliers was attractive as well.

“These are two asset classes that have held up in the recent market turbulence. Investors will be looking more toward diversification in the future,” he said.

“Over the past few years, the focus was on very few names, the high-flying stocks like Apple, Netflix and Amazon.

“Being more diversified should be more rewarding from now on.

“I do like the note.”

HSBC Securities (USA) Inc. is the agent.

The notes settled on Wednesday.

The Cusip number is 40439JXE0.

The fee is 2%.

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