Credit Suisse's barrier notes linked to Dow show good return potential for long-term play

By Emma Trincal

New York, Jan. 3 - Credit Suisse AG's 0% accelerated barrier notes due Feb. 5, 2018 linked to the Dow Jones industrial average offer bulls the potential to outperform the market both on the downside and the upside as long as they are willing to invest for a longer period of time, said Eve Berlinska, structured products analyst at Future Value Consultants.

If the final index level is greater than or equal to the initial index level, the payout at maturity will be par plus 132% to 137% of the index return. The exact upside participation rate will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

If the final index level is less than the initial level but greater than the knock-in level, the payout will be par. The knock-in level is expected to be 70% of the initial index level.

If the final index level is less than or equal to the knock-in level, investors will lose 1% for every 1% that the final index level is less than the initial level.

For bulls

"This note would appeal to a very bullish investor as there is no cap on the return," Berlinska said.

"But the investor should be ready to lock in his capital for a period of four years, which also means that he has to be willing to accept the credit risk of Credit Suisse for four years.

"Someone buying this investment should expect the index to grow as much as possible. The notes provide an opportunity for easy returns if the index shows a moderate to high performance over the course of the four years. Given the leverage on the upside, the instrument gives investors a good opportunity to outperform the underlying index. Even if the market is down, you can still outperform as long as the index decline is above 70% of the initial price. But then, the benefit of the leverage will be lost."

The four-year product is in the leveraged return category and has a longer maturity than most of its peers, she said.

"We still see a majority of short-term notes between 18 months to two years in the leverage category. However, leveraged notes which offer competitive levels of downside protection via a buffer or a low barrier tend to be a bit longer in duration. But since we're comparing this product against other leveraged notes, in a category dominated by shorter-dated maturities, we see a greater level of credit risk here," she said.

Risk

Future Value Consultants assesses risk, return and price using a variety of proprietary scores in order to compare a product with others.

The riskmap is Future Value Consultants' measure on a scale of zero to 10 of the risk associated with a product with 10 as the highest level of risk possible. The credit riskmap is one of the two components of the riskmap and measures credit risk. The other component is the market riskmap, measuring on the same scale the market risk of a product.

The riskmap is obtained by adding the market riskmap and the credit riskmap.

The credit riskmap for the notes is 0.78, compared with an average credit riskmap of 0.68 for products of the same type.

"There is more credit risk than average. It's safe to attribute this result to the long tenor as the credit default swap spreads of Credit Suisse are not among the widest compared with other banks," she said.

The market risk, on the other hand, is lower than comparable products, according to the report. The notes have a 2.28 market riskmap, versus a 2.59 average score for similar products.

"It's slightly lower, and it might be because of the final-day barrier of 70%," she said.

"Also, the Dow Jones industrial [average] has a pretty low volatility compared to other benchmarks, in particular global equity indexes.

"You're also comparing this product with notes that have American barriers or no downside protection at all, which we often see on shorter-dated notes."

Unlike European or "final" barriers, American barriers can be hit at any time during the life of the notes.

"Overall when we average market and credit riskmaps, we find a lower-than-average riskmap of 3.06, compared to 3.27 for similar products. It's mostly the lower market risk that contributes to this," she noted.

Return score

Future Value Consultants measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions: neutral assumption, bull and bear markets and high- and low-volatility environments. A risk-adjusted average return for each assumption set is then calculated. The return score is based on the best of the five scenarios, which for this product is bullish, she said.

"The return score is much better than the average of the same product type," she said, commenting on the notes' return score of 8.66 versus 7.77 for the average leveraged return product.

"This is the no-cap factor. This product rates much better than its category because most of those products have some sort of a cap. Uncapped notes usually score very well on the return scale, especially for longer-term products when you have the potential to compound more gains," she said.

"Also the score is established based on the best market scenario, which is bullish in this case. You would get the best performance in a bull market, and given the uncapped upside, you get a high return score."

Future Value Consultants assigns a probability of return outcome using a Monte Carlo simulation based on various parameters such as volatility, dividends and interest rates.

The probability table associated with this product shows very good odds of generating a higher profit under the bullish scenario compared to the risk-neutral scenario. The neutral scenario represents a return equal to the risk-free rate.

The probability of this investment generating an annual return in the lower bucket (a gain between zero and 5%) is 52% in the neutral scenario and 32% in the bullish scenario, according to the report.

"Obviously, the odds of making less are greater in the risk-free environment," she said.

But for the highest return bucket (a gain of more than 15% a year), the odds are much greater with the bull market assumption than with the neutral scenario with probabilities of 15.2% and 2%, respectively.

On the downside, there is a 4.6% probability of losing more than 15% in the bullish scenario, compared with 11.2% in the neutral scenario, she noted.

All-products comparison

Future Value Consultants rates each product and compares it with the average for the same product type. But it also establishes average ratings for all products it recently scored. This "all-products" category is skewed due to an abundant presence of reverse convertibles, she explained.

"If you compare this note with all products, you will find better results on the risk and return scales as well. In fact the product does even better than when compared to its peers," she said.

The average riskmap for all products is 3.57, versus the notes' 3.06 riskmap, she said, and the average return score for all product types is 6.98, versus the notes' 8.66 return score.

"That is partly because the majority of all products is made of reverse convertible and autocallable income products," she said.

"Those are usually linked to stocks, especially reverse convertibles, and as we know, single stocks are more volatile than indexes.

"The return score is also lower because for the amount of risk you're taking, you are not getting compensated adequately. The higher risk level observed in the 'all-products' category has to do with the high representation of income products, which often come with more volatile underlying assets and the inclusion of an American barrier. In addition, those structures are capped by the income you receive. As a result, you can't participate in further growth."

Price, overall scores

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10. This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

"Back into the comparison of this product with its peers, we find a pretty high price score of 8.67 against 7.78," she said.

"This indicates a good value in a competitive market. The issuer spent more on the options. The longer term also helps as fees are calculated per annum."

The final rating is the overall score. It measures Future Value Consultants' general opinion on the quality of a deal. The score is simply the average of the price score and the return score.

The notes have an 8.66 overall score, compared with an average of 7.77 for products in the same category.

"This is an impressive overall score, which is obviously due to very good price and return scores," she said.

"The notes offer the potential of gaining much better than the average leveraged product. It captures a magnified performance through uncapped leverage on the upside. As long as investors are prepared to hold the notes to a longer maturity, they can expect greater potential return."

Credit Suisse Securities (USA) LLC is the underwriter.

The notes are expected to price Jan. 31 and settle Feb. 5.

The Cusip number is 22547QF84.

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