HSBC’s $250,000 phoenix autocalls on Eli Lilly provide risk mitigation with memory feature

By Emma Trincal

New York, Feb. 11 – HSBC USA Inc.’s $250,000 of phoenix quarterly review notes with a memory coupon feature due Feb. 23, 2023 linked to the common shares of Eli Lilly & Co. give investors a chance to receive all coupon payments during the term of the notes providing that the underlying closes at or above the coupon barrier at least once.

The notes will pay a contingent quarterly coupon at an annualized rate of 15.5% if the shares close at or above their 80% coupon barrier on the observation date for that quarter, according to a 424B2 filing with the Securities and Exchange Commission.

If a coupon payment is missed because the stock closes below the barrier, it will be paid on the next coupon payment date that the stock closes at or above the barrier.

The notes will be called at par plus the contingent coupon if the shares close at or above the initial price on any quarterly observation date.

The payout at maturity will be par plus the contingent coupon unless the shares finish below the 80% trigger level, in which case investors will be fully exposed to the stock’s decline from its initial level.

Likely call

“I like the memory feature. If you miss one or two coupons, you can get them later,” said Clemens Kownatzki, finance professor at Pepperdine University.

“Your coupon is at risk. But with the memory feature some of that risk is mitigated.

“The main concern is getting your full principal back at maturity. There is some downside risk due to the small barrier. It’s also a short-term paper. Those two factors can be a concern.

“At the same there is perhaps an equal chance that you might get called, and if you do get called, it’s likely to happen at the end of the first quarter. That’s OK because 3.87% is not a bad return for three months.

“All in all, the note seems to be very attractive.”

A changing market

The current choppiness of the stock market adds some risk to investors, however.

“Markets are more volatile now as interest rates and inflation are rising,” he said.

Investors are concerned about the Federal Reserve’s plans to hike short-term interest rates and perhaps adopt a more hawkish stance due to high inflation numbers released on Thursday. Higher long-term rates have weighed on the performance of tech stocks. Growing tensions between Ukraine and Russia pushed stocks lower on Friday.

“We’re seeing a bit of a regime change with interest rates moving higher,” he said.

“Investors are probably going to change the risk-return when looking for decent yields. So far there were no good alternatives,” he said.

“You couldn’t find any yield in fixed-income. Investors have been looking for yield in government bonds, investment-grade bonds, junk bonds. Dividend yields on stocks are not that attractive either.”

This included the dividend yield of Eli Lilly.

“It’s only 1.6% and that’s for the entire year,” he said.

In comparison, investors in the notes may receive 1.29% a month.

“This speaks to the popularity of these autocalls at least for income investors who need to find attractive interest rates,” he said.

“In general, equity derivatives have become a popular source of income. You don’t have the upside of the stock. But you have above-average coupon rates with some protection on the downside.”

Entry, value

The entry point for the deal, which priced on Feb. 4, was relatively attractive as well, he noted.

The stock closed at $242.27 at pricing, about 15% off its 52-week high of December.

One caveat was the valuation of the stock, which is “on the higher side” compared to its peers like Bristol-Myers, Pfizer and Merck, he said.

The three stocks have price-per-earnings of 21.32, 15.24 and 15.73, respectively, versus 39.10 for Eli Lilly.

“Anything highly valued can drop more; so, I would say the valuation of Eli Lilly is a little bit rich,” he said.

“At the same time, the market no longer interprets P/Es as in the good old days. Most of the top-performing stocks have had high multiples.

“The stock is 15% off its high. The overall market has also dropped this year. It’s not at its high anymore.”

The S&P 500 has fallen 7.3% so far this year and the Nasdaq, 11.85%. The Healthcare Select Sector SPDR ETF, which holds Eli Lilly as its eighth largest constituent, has declined by 7.15% year to date.

“We see a retracement across the board.

“As much as the 80% barrier is a bit thin –and that certainly increases the risk of losses – I still like the notes because you are likely to be called.

“From the perspective of getting this type of cash flow income, its’s an interesting product.

“And if you breach the coupon barrier and miss a payment, you have that catchup feature. I like that,” he said.

HSBC Securities (USA) Inc. is the underwriter, and JPMorgan Chase Bank, NA and J.P. Morgan Securities LLC are the placement agents.

The notes settled on Feb. 9.

The Cusip number is 40439JZQ1.

The fee is 1%.

The final price will be the average of the closing prices on Feb. 13, 2023, Feb. 14, 2023, Feb. 15, 2023, Feb. 16, 2023 and Feb. 17, 2023.

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