Advisers compare two ‘Covid-inverse’ bets on Southwest with autocalls issued by HSBC, Barclays

By Emma Trincal

New York, Aug. 26 – When choosing an autocallable note, the coupon rate and underlying are far from being the only criteria of choice, advisers said. Barrier levels and contingency versus fixed income also play a key role as illustrated by their comments on two recently issued autocallable note offerings distributed by UBS and tied to the same underlying stock.

HSBC’s fixed rate

The first one – HSBC USA Inc.’s $15 million airbag autocallable yield notes due Aug. 23, 2022 linked to the common stock of Southwest Airlines Co. – pays a fixed coupon at a rate of 7.7% per year, according to a 424B2 filing with the Securities and Exchange Commission. Interest is payable monthly.

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

The barrier at maturity is set at 85% of the initial price. Investors will receive shares and not cash if the price falls below the barrier.

Barclays’ contingent coupon

The other product, a three-year note, pays a contingent coupon. But the barrier level both for the coupon and for principal repayment at maturity is substantially lower.

Barclays Bank plc priced $7.75 million of trigger autocallable contingent yield notes due Aug. 16, 2024 linked to Southwest Airlines stock, according to a 424B2 filing with the SEC.

Each quarter, the notes will pay a contingent coupon at the rate of 8% per year if the shares close at or above the downside threshold level, 64.85% of the initial share price, on the observation date for that quarter.

The notes will be automatically called at par plus the coupon if shares close at or above the initial share price on any quarterly observation date after six months.

If the notes are not called and the final share price is greater than or equal to the threshold level, the payout at maturity will be par plus the final coupon. Otherwise, investors lose 1% for every 1% decline of the share price from the initial level.

Covid-related

“Southwest is very volatile. We bought some of it last year early in May. The price has gone up 78% since. Volatility works both ways,” said Steve Doucette, financial adviser at Proctor Financial.

The implied volatility of the stock is 38% versus 18% for the S&P 500 index, which includes Southwest as one of its components. The airline stock however is less volatile than Delta Air Lines Inc. and American Airlines Group Inc., which have implied volatilities of 44.78% and 54%, respectively.

“As soon as Covid comes back, all those airlines get hit,” he said.

“The airlines stocks are Covid-inverse related stocks.”

Currently trading at $50 a share, Southwest is 23% off its April peak but remains up 8% for the year.

The decline since the spring can be attributed to the spread of the Delta variant, he said.

Barriers of entry

When comparing Barclays’ deeper barrier and contingent coupon with the HSBC notes paying a fixed rate of approximately the same amount but with approximately 20 percentage points less in barrier protection, Doucette said he preferred the former.

“With the Barclays, you miss a coupon along the way, so be it. At least I have a 65% barrier, which is pretty decent. I’m more comfortable with that,” he said.

Even when considering the fixed rate in the other deal, which adds a layer of downside protection of 7.7%, the entire protection – 15% on a contingency basis and 7.7% as a buffer-like cushion – still doesn’t match the 35% barrier protection seen with the other deal, he said.

Time is also a factor.

“You’re looking at a 22.7% protection over the next 12 months if you include the coupon. But it’s only 12 months. Adding time makes me more comfortable and that’s another reason I’d go with the three-year note,” he said.

All relative

While Doucette has a slight preference for the Barclays deal due to its deeper barrier and longer maturity, he would not invest in either offering.

“We’re still dealing with a lot of uncertainty around Covid. I don’t think I’d want to ride this airline industry, much less on one stock,” he said.

Southwest Airlines is more likely to recover than its U.S. airlines competitors due to its focus on the domestic market, said Burkett Huey, equity analyst at Morningstar, in a research note.

The company has reported revenue improvement with the easing of travel restrictions, the analyst noted.

“We believe domestic leisure travel is the most likely form of air travel to be entirely unaffected by the pandemic over the long run,” he said.

In the meantime, however, Southwest has been under pressure during the pandemic, reporting daily cash burn and losses.

“I haven’t looked at their balance sheet, but they had serious revenue issues last year when people canceled their flights,” said Doucette.

“Things may be better now, but you still have risk with the Delta variant.

“We’ll see if this third vaccine can improve the situation. Because you’re really betting against Covid.”

Dangerous bet

Matt Medeiros, president and chief executive officer of the Institute for Wealth Management, said he was just not comfortable with the underlying security and even sector.

“I would be very nervous about investing in the airlines. I would understand why you would want significant downside protection on it,” he said.

Medeiros tends to prefer longer maturities as a risk-reducing feature.

“I would be less attracted to the shorter-term note, for sure,” he said.

Southwest Airlines in itself was “a good airline,” he said.

“But I think any exposure to this sector is highly speculative. There are a lot of possible headwinds. Covid is one of them. Oil prices is another. There are so many things that could go wrong.”

Term and depth

Medeiros compared the 85% barrier on the HSBC one-year note with the 65% level for the three-year Barclays note.

“The barrier is more of a reflection of the time,” he said.

“Putting a barrier on a shorter note is more expensive, which is why this one is thinner.

“With a stock as volatile, you do want more protection.

“So, if I liked the sector, I would probably go for the Barclays.

“But I don’t. It’s just too much of a speculative bet.”

HSBC Securities (USA) Inc. is the underwriter for the HSBC deal with UBS Financial Services Inc. as agent.

The notes (Cusip: 40439K383) settled on Aug. 23.

The fee is 1.5%.

UBS Financial Services Inc. and Barclays Capital Inc. are the agents for the Barclays offering.

The notes (Cusip: 06747X870) settled on Aug. 18.

The fee is 2%.

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