Credit Suisse's knock-out notes on Johnson Controls said to offer competitive buffer, terms

By Emma Trincal

New York, Dec. 8 - Credit Suisse's planned knock-out notes on Johnson Controls, Inc. offer an attractive structure to investors with a higher level of protection than a regular growth or income product with attractive potential return, sources said.

Credit Suisse AG, Nassau Branch plans to price 0% capped knock-out notes due Dec. 29, 2011 linked to the common stock of Johnson Controls, Inc., according to an FWP filing with the Securities and Exchange Commission.

If the closing price of Johnson stock falls by more than the knock-out buffer of 31% during the life of the notes, the payout at maturity will be par plus the stock return, which could be positive or negative.

Otherwise, the payout will be par plus the greater of the stock return and 10%.

In each case, the payout will be subject to a maximum return of 20%.

Reverse convertible theme

"This is a variation on the reverse convertible theme. If volatility is high, pricing becomes very attractive and you can get very good terms," a structurer said.

"Unlike a reverse convertible though, here there's a small chance that the investor would not get paid anything. That makes the product even cheaper and the terms potentially more attractive."

Suzi Hampson, structured products analyst at Future Value Consultants, said that the returns of a knock-out could be at least "in theory" more attractive than the coupon paid in a reverse convertible, simply because the investor is no longer entitled to a minimum return if the stock price breaches the 31% threshold while the reverse convertible coupon gets paid in any case.

Better than a buffer

Hampson pointed to the downside protection as one of the most appealing features of the deal.

"It's not so much the return potential. People mostly like those deals for the level of protection because you do get a positive return even when the underlying stock falls," she said.

Hampson said the notes were more of a "growth" than an "income" product.

"Income products tend to generate income monthly and they offer fixed-interest payments. That's not the case here. On the other hand, it's more like growth since you can participate in the appreciation of the stock, up to the cap," she noted.

"Here, even if the stock falls by 30%, you do get a 10% return. It's much better than a buffer that gives you just par."

Better terms

Eric Greschner, portfolio manager at Regatta Research & Money Management, said that "the structure is interesting" as terms were "more attractive" than most reverse convertible products he recently saw.

"The [reverse convertible] barriers are 20% with coupons in the 8% to 12% annualized range with mostly six to 12 month maturities," he said.

The upside of the knock-out notes with a minimum coupon of 10% up to a potential maximum return of 20% was "in line," he said, with the reverse convertible products he has recently seen in the market.

But the 31% barrier was "wider than [barriers] I'm currently seeing for stocks with relatively similar volatility," he said.

The notes offered the advantage of giving investors a "substantially higher contingent capital appreciation", he added.

New stock on the block

Sources noted that the use of Johnson Controls shares was relatively recent.

Friday, Morgan Stanley priced $1.7 million of 0% knock-out notes due Dec. 21, 2011 linked to this stock.

Prior to that, Johnson Controls had only been used two times this year, in January and February under the format of two Barclays' reverse convertibles, according to data compiled by Prospect News.

Before 2010, this underlying was only used five times, all in 2007, according to Prospect News.

Both the Credit Suisse and the recently priced Morgan Stanley knock-out notes on Johnson Controls offered virtually the same structure, except for a 30% knock-out buffer in the Morgan Stanley deal.

Both are distributed by J.P. Morgan Securities LLC.

Volatility

Johnson Controls provides automotive interiors. The stock is up 40% so far this year.

Hampson noted that the stock's implied volatility at 34% was "quite high."

"If I was interested in that stock or this industrial sector, I would say it's a fairly attractive structure," said Greschner.

"I would be cautious though as the stock is closing in on its 2007 highs. Investing in the notes however may be a more prudent play than owning the stock outright."

The stock peaked in November 2007 at nearly $43. It closed at $38.33 on Wednesday.

The notes (Cusip: 22546EL77) are expected to price on Friday and settle on Dec. 15.

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