HSBC’s barrier notes with autocall on indexes pose risks after big market runup

By Emma Trincal

New York, Sept. 12 – HSBC USA Inc.’s $919,000 of 0% barrier participation notes with autocall feature due Sept. 8, 2025 linked to the least performing of the S&P 500 index and the Russell 2000 index offer an attractive call premium and uncapped participation at maturity. But advisers were concerned about the downside risk should the notes fail to be called.

The notes will be called automatically at par plus a premium of 11.5% if each index closes at or above its initial level on Sept. 4, 2024, according to a 424B2 filing with the Securities and Exchange Commission.

If each index finishes at or above its initial level, the payout at maturity will be par plus 200% of the laggard index’s return.

If the worst performer declines but finishes at or above its 70% barrier level, the payout will be par.

Otherwise, investors will be fully exposed to the decline of the worst performer from its initial level.

Range bound

“11.5% is a nice coupon if the market is flat. We had a robust runup this year, at least if you look at the S&P. The Russell didn’t do that well,” said Tom Balcom, founder of 1650 Wealth Management

The S&P 500 index has gained more than 16% so far this year; the Russell 2000 rose 5.35%.

Balcom said the call feature was attractive for investors who do not expect a lot more growth.

“You’ll get compensated even if the market does nothing. The two-year Treasury has a great yield of 5%. With the note, you’re getting an extra 6.5% premium on top of that for taking the risk. It seems fair.”

One year up

Balcom, however, did not downplay the risk at maturity.

“If you don’t get called your principal is at risk. You have a nice 70% barrier, but the question is: is it enough?”

The answer will depend on how fast the market recovers, he said.

“You’ve missed the call, so you’re negative at the end of year one. Now you only have one more year to make up for it.

“You’ll need a strong recovery to take advantage of this 2x leverage. It would be nice to have some growth since there’s no cap.”

But Balcom said it is hard to predict what the market will be like in two years given the current uncertainty.

“A 70% barrier is always enough until it isn’t,” he said.

“That said, we’ve had very speedy recoveries in 2020 and also this year. I think the market could rebound after a year quite quickly, but you can’t tell for sure.”

Second version

Separately, HSBC priced a second offering. Only two terms were different. First, the Nasdaq-100 index replaced the S&P 500 index as one of the underliers in the worst-of along with the Russell 2000 still in place; second, the call premium was raised to 14.7%.

“This one has a little bit more risk. The Nasdaq had a huge runup. I’m always cautious when I see people buy at a high, I don’t care what index it is. The S&P is up a lot, but the Nasdaq is even higher,” he said.

Both benchmarks hit a 52-week low 11 months ago. Since then, the S&P 500 index has gained 28% and the Nasdaq-100 has jumped 46%.

“You’d be better off getting called after one year,” he said.

Extreme valuations

Steven Jon Kaplan, founder, and portfolio manager at TrueContrarian Investments found both notes risky based on current market valuations.

“The risk of losing a significant amount of money is quite high,” he said about the notes tied to the S&P and the Russell 2000.

“The S&P is the most overvalued in its history. It could easily fall below 30%.

“It’s close to double its fair value. But there’s also the fact that T bills, which have the highest yields since 2000, are far more attractive alternatives.”

Both of those combined factors made the notes “extremely risky,” he said.

Kaplan noted that even if the S&P 500 index is currently approximately 7% lower than its all-time high of Jan. 4, 2022, it remains “overvalued.”

He pointed to the fact that when the S&P 500 index peaked in January 2022, the one-year T Bill yielded 0.4%. Now, it is close to 5.5%

“T Bills are competing with stocks much more seriously. It makes any investment in the S&P much more dangerous.”

AI bubble

The second offering of notes with the exposure to the Nasdaq-100 index was even more unattractive, according to this portfolio manager.

“The Nasdaq-100, or QQQ if you look at the ETF, is worse because it’s more volatile than the S&P.

“QQQ has a relatively high exposure to the most overvalued large-cap stocks, those AI darlings, which people call the Magnificent Seven. These stocks are in a dangerous bubble.

“Certainly, having a buffer would help. If you could have some downside payout it would be even better.”

But the fundamentals remained negative, he said.

“Both notes are risky in this market. And you’re not getting compensated for that kind of risk.”

HSBC Securities (USA) Inc. is the agent for both issues, which settled on Sept. 6.

The fee for each offering is 0%.

The Cusip number for the first deal is 40447AJE5.

The Cusip number for the second one is 40447AJF2.

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