HSBC’s contingent income barrier autocalls on cruise line stocks show eye-catching 48% coupon

By Emma Trincal

New York, Oct. 11 – HSBC USA Inc.’s $1.05 million of autocallable contingent income barrier note due April 8, 2024 linked to the least performing of the stocks of Royal Caribbean Cruises Ltd. and Carnival Corp. wowed advisers for the size of its coupon. Despite the risks and the volatility associated with the underlying investment theme, sector and stocks, advisers said they liked the risk-adjusted return given the depressed entry prices.

The notes will pay a contingent monthly coupon at an annualized rate of 47.88% if each stock closes at or above its coupon trigger level, 70% of its initial level, on the observation date for that period, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par plus the coupon if each stock closes at or above its initial level on any monthly call observation date after six months.

If the notes are not called and each stock finishes at or above its coupon trigger, the payout at maturity will be par plus the final coupon.

If the worst performer finishes below its coupon trigger but at or above its 50% barrier, the payout will be par. Otherwise, investors will be fully exposed to the decline of the least-performing stock from its initial level.

Pure equity

“That’s crazy good. So, you’re getting 4% a month. A two-year Treasury gives you 4.3% a year. You’re getting compensated almost 12 times that for the risk you’re taking. I think it’s very nice,” said Tom Balcom, founder of 1650 Wealth Management.

The return was so high, the note could be considered as a growth instrument despite being “capped” by the coupon, he said.

“If you’re bullish on those two stocks you get a return that’s pure equity. You could use the note as equity replacement in the portfolio,” he said.

High volatility

The issuer was able to pay the “extraordinary” coupon rate by selling the high implied volatilities associated with each stock.

“The volatility on those two names is so high, that’s how they can pay you this huge coupon. Forty eight percent a year. ...I’m shocked.”

The implied volatility of Royal Caribbean is 93.77% and Carnival has an implied volatility of 113.31%.

A one-year implied volatility of 100% means that the market prices a high probability for the stock to move within +/- 100% of its current price in one year.

“They can move all over the place, up or down. But the good news is the stocks are already down a lot,” he said.

Carnival closed on Tuesday at $6.64, or 74% off its Nov. 5 high of $25.29. Royal Caribbean lost 59% from its high of $40.69 posted on Nov. 8.

Added safety

Balcom cited a few risk mitigation factors, which originated from the structure and prices.

“The stocks are down so much it gives you a comfortable cushion in addition to the barrier. The entire market is down from the current pullback but those cruise ship names have literally been hammered,” he said.

Anytime investors earn their monthly coupon, they get additional protection, he noted.

“I love the coupon for the return. But it’s also a defensive item. Each month you build up an additional 4% buffer. It may help offset some of your losses,” he said.

While worst-of are always riskier than exposures to a single stock, the choice of the underliers contributed to reduce the risk.

“These are two very similar companies operating in the same industry. That means the stocks are more likely to move in sync, which is good.”

Positive outlook

Balcom was relatively optimistic about the prospect of the cruise industry.

“The space was badly hit during the pandemic. But it has recovered since last year thanks to the vaccines. We’re now in a post-Covid environment although there is always the risk of a new variant,” he said.

“For now, though, I’m cautiously optimistic. Many of my clients are going on cruises. People want to go on vacation. Life has returned to normal. With inflation eating up households’ budgets, going on a cruise to see exotic places for a modest, affordable price is attractive to many Americans.”

One wildcard

Balcom sees the main risk in surging energy costs.

“A spike in oil prices would make fuel very expensive for cruise companies and could affect their bottom line,” he said.

In conclusion, Balcom said he may consider the notes on a limited basis.

“I may use it for more aggressive clients if the notes pique their interest. It’s riskier than most other notes, but it’s unique,” he said.

Good timing

Another financial adviser liked the risk-adjusted return of the notes.

“It’s a fairly generous payoff especially when you consider the entry price. The stocks are more than 60% off their highs. They’re not that much higher than their rock-bottom levels of March 2020. You’re buying at very low levels. The timing is pretty good,” he said.

It’s the economy...

This adviser pointed to macroeconomic factors as the main source of uncertainty.

“The risk is not so much another wave of Covid. The risk is recession,” he said.

“When you’re in a recession, households cut down on discretionary expenses like traveling or going on a cruise.

“This is why those stocks are so depressed right now. Covid was the 2020 story. Now we’re looking at the economy. People are reducing their spending. They’re buying what they need, not so much what they want. It hurts consumer discretionary stocks but also almost all sectors. Consumer discretionary stocks are just hit even harder.”

Barriers

Despite this negative outlook, this adviser said he liked the notes.

“Both stocks are so depressed, I don’t think they’re likely to go below the 70% barrier. You have a good chance of getting paid maybe not every single month but often. You’re also likely to be called,” he said.

The six-month call protection offered investors a chance to collect a number of coupon payments prior to the first call date, which was also a positive, he added.

“I also like the protection at maturity. Even with a worst-of, a 50% barrier is very good, mainly because you’re buying those stocks at such a cheap price.

“You’re getting very well compensated. It’s one of the best payoffs I’ve seen in a note in a long time. I might consider it,” he said.

HSBC Securities (USA) Inc. is the agent.

The notes settled on Friday.

The Cusip number is 40441XRJ1.

The fee is 0.7%.

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