HSBC’s autocall step-up premium on indexes seen as growth note due to rate of return, memory

By Emma Trincal

New York, March 1 – HSBC USA Inc.’s 0% autocallable barrier notes with step-up premium due March 24, 2026 linked to the least performing of the S&P 500 index, the Russell 2000 index and the Dow Jones industrial average are attractive for the memory call feature and the size of the call premium, a financial adviser said. As a result, he considered the investment as a growth rather than an income product.

The notes will be called at par plus a call premium if each index closes at or above its initial level on any semiannual observation date after one year. The premium is 11.3% per year, according to an FWP filing with the Securities and Exchange Commission.

If the notes are not called, the payout will be par unless any index has finished below its 75% barrier level, in which case investors will lose 1% for each 1% decline of the least-performing index from its initial level.

Sweet memory

Michael Kalscheur, financial adviser at Castle Wealth Advisors, liked the “snowball” structure, which pays a call premium upon the automatic call rather than a contingent coupon seen in the common Phoenix autocallables.

Since the premium of a snowball is triggered at a higher threshold than the Phoenix’ coupon barrier, it tends to be higher than a typical contingent coupon rate. Another advantage of the snowball is the memory feature: missed premium can be captured at a later date whenever a call occurs.

“This is a very interesting one...it’s off the beaten path,” said Kalscheur.

“I really like these snowballs. If I don’t get called out right away, I am not losing money. I catch up with the lost coupons.”

He said he particularly liked the one-year call protection.

“I always complain about autocalls because you get called after 90 days,” he said.

The memory and the call protection together made the structure particularly appealing.

“You know that you’ll get a rate or return of 11.3% a year at some point in time if you’re called. And the return is extremely competitive. Anytime the payout is above 10% I’m interested because I think it’s a fair rate of return for an equity-type of risk. So, it definitely makes that mark.

“Obviously, this is not an income product. It’s more like growth. A 12% annual return is pretty darn good,” he said.

Tenor

Kalscheur said he also liked the maturity. While the notes may be called before the end of the term, investors should be prepared to hold the security during its entire term.

“It’s a five year and for us, it’s a good thing. It fits very nicely with our investment methodology. Most of our notes are four or five years anyway. As long as you don’t need the liquidity in the next five years, let the structured note work for you. We have no issues with the credit quality of the issuer. So, this five-year tenor is a positive thing for us,” he said.

One downside was the fee of 2.4% consisting of a 2% commission and a 0.4% structuring fee.

“If you get called out in a year, that fee is outrageous. If it’s in five years, it’s a different story,” he said.

Market risk

The 75% barrier at maturity was acceptable for the period.

“Your principal at maturity...That’s what you have to be worried about although you will most likely be called out in 12 months,” he said.

But the risk of a breach was not so high, he said, looking at data he has collected on the S&P 500 index since 1987.

“Over a 12-month rolling period, the index is positive 73.9% of the time,” he said.

“I know that you have to have three indexes positive at the same time. But the Russell has a 71% probability of finishing positive after one year. Overall, you probably have a two-thirds chance of being called out after just one year. That’s pretty good,” he said.

Risk assessment

Still investors need to be prepared for a long timeframe.

“You still need to assume that you’ll be holding the notes until maturity. And for that reason, you have to be comfortable with the risk. The chance of losing money in any of these indexes in a five-year period...you’re looking at a single-digit probability. That’s not very likely. But it’s something to consider,” he said.

One risk-mitigating factor was the memory as it eliminated part of the uncertainty associated with the payout.

“The snowball effect is huge. It eliminates a lot of the risk you take about short-term volatility,” he said.

“If you get called, you get paid and you get it all. That’s very important.

“With the autocalls that we see, you have to worry about how much you’re going to get paid. You may not get all the coupon. If the market tanks even for a quarter, you may be underwater. I love these snowballs.”

No objection

Kalscheur named a few negative aspects of the product but said he would not be deterred.

“I only see a few reasons why someone may not be interested in the note. One is if you’re not prepared to hold it for five years. Second, if you think the market will do much better over the period. Personally, I think my clients would be very happy with an 11.3% rate of return. But if you’re a raging bull, it won’t work.

“The fee is the only thing I can really complain about. However, the terms of the deal are so compelling, it’s not really such a big deal. Normally a structure will suffer if the fees are too high. But it’s not the case here. The structure is really, really nice. Some things are worth paying for.”

Not so great

Carl Kunhardt, wealth adviser at Quest Capital Management, had a different view.

“I wouldn’t do it, “he said.

“It takes too much time to explain it to a client. It’s a little bit too complex.

“I’m very much of a ‘keep it simple and stupid’ kind of guy.”

Kunhardt added that the fee was too high.

“The client pays upfront. What if it gets called right away?” he said.

“The 11.3% premium...that’s very attractive. But that’s about it.

“I rarely go five years. I don’t like to be locked in.

“I don’t like worst-of. Sometimes they can make sense, but not here and not with three indices.

“If one of those three is down more than 25%, then the 11% return is never going to make up for a loss of principal.”

The semiannual payment, the fact that investors may “catch up” with the coupon later are “the good part,” he said.

“But if you weigh the good part with the challenging part, the challenging part wins out.”

HSBC Securities (USA) Inc. is the agent.

The notes will price on March 19 and settle on March 24.

The Cusip number is 40438C3D1.

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