HSBC’s $10 million buffered autocalls with memory on S&P fund show above-average yield

By Emma Trincal

New York, April 10 – HSBC USA Inc.’s $10 million of buffered contingent income autocallable securities with memory coupon and downside leverage due April 10, 2024 linked to the SPDR S&P 500 ETF provide a variety of appealing features for a short-term note, advisers said. The presence of a buffer, memory feature and a single underlier make the double-digit yield unusually attractive, they noted.

The notes will pay a contingent quarterly coupon at an annual rate of 11.7% if the ETF closes at or above its 87% coupon barrier on the corresponding observation date, according to a 424B2 filing with the Securities and Exchange Commission.

Previously unpaid coupons, if any, will be automatically included whenever a coupon is paid.

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

If the final share price is greater than or equal to the downside threshold level, 87% of initial level, the payout at maturity will be par plus all unpaid coupons.

Otherwise, investors will lose 1.1494% for every 1% decline of the ETF beyond 13%.

No tail risk

Scott Cramer, president of Cramer & Rauchegger, Inc., found the coupon rate appealing but investors needed to be comfortable with the market risk.

“I always wonder why people would do that except for the fact that they want significantly more income than the average fixed-income instrument,” he said.

“You have to be pretty confident that the market is not going to have a meltdown; otherwise, you have to buy your income elsewhere.”

Investors are getting a “much better yield” than regular income, he said.

“The question is: is it worth the risk? It’s a matter of personal opinion. Personally, I would not allocate this to my fixed-income portfolio. It has more risk than most people think,” he said.

Buffer, memory

Cramer, however, stressed some of the benefits of the notes.

“You have a 13% buffer, which is good. The gearing will create a little bit of extra loss. But it’s not significant enough to make a difference,” he said.

For instance, a 20% decline in the ETF share price would cause investors to lose 8% of principal at maturity compared to only 7% with a straight, unlevered buffer of the same size, he noted.

“The memory is good too. You have a second, third and last chance to catch up with coupons you could not get before.”

Tradeoff

But the risk was still too high.

“If something goes bad in the market, a one-year term may not give you enough time to recover,” he added.

Cramer said he would feel more comfortable with lower-yielding but less risky alternatives, citing some insurance products.

“You can get a three-year yielding 5% from an annuity or a GIC,” he said.

Guaranteed Investment Contracts (or GICs) are yield-generating insurance products comparable to CDs.

“The tradeoff of the notes is that you’re getting a lot more income but with a lot more risk,” he said.

“Someone may like the risk-reward. I wouldn’t do it.”

Short-term bet

Carl Kunhardt, wealth adviser at Quest Capital Management, was more concerned about the call risk.

“I like pretty much everything except the fact that you’re going to get called when everything is working fine, probably at the end of month three,” he said.

Given the short maturity and the presence of a buffer, the size of the coupon was attractive.

“11.70% is really good. On a quarterly basis it’s almost 3%. Yes, you can get money market yields at 4.5%, but it’s annualized. To make 3% quarterly is something else altogether,” he said.

“But again, if you’re above pricing, the note goes away. So, in reality it’s a 3% quarterly play.”

Because the automatic call was so likely, Kunhardt downplayed the downside risk at maturity.

Downside protection

“The 13% buffer is fair. It’s sufficient for me unless you believe the market will be down 13% in one year. I’m not really in that camp,” he said.

“Even if the market drops more than 13%, you’re still better off than being long the index.

“It’s a moot point anyway because I don’t think the note will get to maturity. I don’t see it as a one-year. I see it as a three-month product.”

The downside gearing was not a concern.

“In general, I don’t like leverage. But I don’t mind it so much because as I mentioned, I don’t think you’ll be holding the notes for one year. Also, all those good things – the double-digit, the memory, the buffer itself – have to be paid for. The gearing may offer the benefits of those terms at a lower cost,” he said.

When notes are automatically called early, reinvesting the proceeds for an identical yield is not always easy, creating for advisers an additional burden known as “reinvestment risk.”

“Since the notes will be called before maturity, I’m more focused on reinvestment risk than on downside risk,” he said.

“But I don’t see that much of a problem now that we’re in a rising rates environment.”

ETF vs. index

One more important issue for this adviser was the use of an ETF in place of the index as underlier.

“ETFs are not direct mirrors of the index they replicate. For one thing you have the expense ratio. Even if it’s an extremely small fee, it’s still not the index,” he said.

Also, ETFs don’t necessarily replicate the exact number of components of the index or their exact weighting, he added, pointing to the quarterly rebalancing of the S&P 500 index.

“There are timing issues between the rebalancing of the index and the buy and sell of the ETF. Not all the funds tracking the S&P 500 index have 500 components,” he said.

The SPDR S&P 500 ETF right now has 503 holdings.

“There is always a difference between an index and an investable security tracking that index. It’s not a significant difference. But it is a difference,” he said.

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, did not find the gap between the coupon rate and yields earned from risk-free assets compelling enough to warrant taking the equity risk associated with the notes.

“This note to me seems overly complicated,” he said.

“But more importantly, the payout doesn’t fit with my market outlook of a potential 40% downside for a 20% at best on the upside.”

The 11.70% cap of the notes was below his 20% potential upside scenario.

“But this is fine. It’s the downside that’s problematic. There is not enough downside protection here to cover my base scenario of a potential 40% market drop,” he said.

Since finding structured notes that meet his market expectations has become challenging and given his bearish market view, Chisholm said he is currently positioned mainly in cash and Treasuries.

“I can get close to 5% in a Treasury. Why would I take the equity risk?” he said.

One-year Treasury bills are currently yielding 4.685%.

HSBC Securities (USA) Inc. and Morgan Stanley Wealth Management are the agents.

The notes will settle on Tuesday.

The Cusip number is 40441X4N7.

The fee is 0.1%.

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