HSBC’s $2.75 million autocalls on financial stocks show good terms, but Fed controls the game

By Emma Trincal

New York, Oct. 13 – HSBC USA Inc.’s $2.75 million of autocallable contingent income barrier notes with memory coupon due Oct. 7, 2022 linked to the least performing of the common stocks of Wells Fargo & Co., Citigroup Inc. and Charles Schwab Corp. offer an unusual mix of financial underlying stocks with Citigroup the most used name in recent worst-of deals. The outcome of the investment will largely depend on what the Federal Reserve will do on both ends of the yield curve, an adviser said.

The notes will pay a contingent quarterly coupon at an annualized rate of 12.46% 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. Previously unpaid coupons, if any, will be automatically included whenever coupon payments are made.

The notes will be called at par plus the coupon, and any previously unpaid coupons, if each stock closes at or above its initial level on any quarterly call observation date.

If the notes are not called and each stock finishes at or above its 70% barrier value, the payout at maturity will be par plus the final coupon plus any previously unpaid coupons. Otherwise, investors will be fully exposed to the decline of the least-performing stock from its initial level.

Rate-sensitive

“As rates are moving higher, interest rates volatility is also picking up, which makes pricing more attractive,” a market participant said.

“Investors can get more optimal terms as evidenced by this 12.5% coupon. Financial stocks are rate-sensitive, and right now, a lot of new things are happening in terms of Fed policy and inflation.”

Appetite for financial stocks has been seen in the performance of the Financial Select Sector SPDR fund.

The ETF tracks the financial sector of the S&P 500 index, including the three underlying stocks, which are among the top 10 holdings. Since its 52-week low a year ago at $23.25, the ETF has increased by 65% to $38.27.

Financial stocks have been popular with the 10-year Treasury moving higher as banks’ profits benefit from a steeper yield curve.

One-year play

The structure presented several appealing terms, starting with the short-term maturity, this market participant said.

“The one-year makes sense. People are sitting on cash. They’re not making anything on money market funds. They’re looking for ways to deploy cash and preserve some liquidity,” he said.

The short maturity may have helped pricing as well.

“The rule of thumb is that short-term notes may give you better pricing as there’s a greater chance of breaching the barrier over a short period of time. Short-term volatility is always higher than long-term volatility.”

This was one important factor leading to the 12.5% coupon, he said.

“There’s more juice in the pricing.”

The implied volatilities of the underlying stocks also helped at 39.56% for Charles Schwab and 38.67% for Wells Fargo. Citigroup’s implied volatility is slightly lower at 31.37%.

Good memory

Along with the short tenor and high coupon rate, the memory feature was also beneficial to investors.

If for instance investors miss the 3.115% coupon payment on the first quarterly observation date but meet the barrier condition on the second observation, they will pocket 6.23% after six months.

“I see the memory coupon as a middle-ground between fixed rate and contingent coupon,” the market participant said.

“It gives investors greater certainty. They know they’ll get full payment as long as they get one payment. I like using the memory function. People like it on all sorts of durations. I don’t think it matters if you’re using it on a one-year or a five-year product.”

Wells Fargo, inverted curve

Lance Roberts, chief investment strategist at Clarity Financial, was not too keen on the choice of underlying stocks.

“It’s a good yield. I’m OK with the notes. But I’m now negative on bank stocks, especially Wells Fargo,” he said.

“Even Schwab could be hit if there is a pullback due to their dependence upon trading.”

Roberts said his outlook on bank stocks was positive last year when the Federal Reserve expanded its balance sheet as the Covid-19 pandemic hit the U.S. economy.

“That’s what we needed then. But now, Fed Fund futures are predicting two rate hikes in 2022, one in June, one in December. Some believe it may even happen sooner than that,” he said.

The Fed minutes released Wednesday revealed that the Fed could begin tapering its monthly bond purchases as early as mid-November. Such a move is expected to increase yields on the long end of the curve since the buying of assets will be reduced.

But the market is likely to see in the Fed’s ending its QE policy a sign of further tightening. Investors are already grappling with the prospect of short-term rate hikes, which may impact the shape of the yield curve.

“If you invert the curve, it’s not good for banks’ profit margins,” he said.

“A slower economic growth, an inverted yield curve, slower earnings growth, these don’t give you good reasons to buy bank stocks.

“In addition to that, I see too much risk in owning Wells Fargo. That stock is likely to be the worst performer.”

HSBC Securities (USA) Inc. is the agent.

The notes settled on Oct. 7.

The Cusip number is 40439JPU3.

The fee is 1%.

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