Credit Suisse’s contingent coupon autocallables on Netflix see little enthusiasm among advisers

By Emma Trincal

New York, May 21 – Credit Suisse AG, London Branch’s contingent coupon autocallable reverse convertible securities due Aug. 31, 2020 linked to the common stock of Netflix, Inc., despite a double-digit return and a low barrier, failed to appeal to fee-based advisers who tend to avoid autocallable payouts when the risk is tied to a single company.

Interest is payable monthly at an annual rate of 10% if the stock closes at or above its 57% knock-in level on a monthly observation date, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par if the shares close at or above the initial share price on Nov. 25, 2019, Feb. 25, 2020 or May 26, 2020.

The payout at maturity will be par unless the shares finish below the initial level and close below the knock-in level any day during the life of the notes, in which case investors will receive a number of shares equal to $1,000 divided by the initial share price or, at the issuer’s option, an amount in cash equal to the value of those shares.

Single name

“We don’t pick individual stocks, and I don’t have any particular deep knowledge of Netflix,” said Michael Kalscheur, financial adviser at Castle Wealth Advisors.

“I guess if I did, I might be willing to take the risk, although I doubt it.”

The Internet entertainment service company is one of the high-performing “FANG” stocks along with Facebook, Amazon and Google’s parent company Alphabet.

The most likely outcome, he said, is a call in six months on the first call date.

“You’re probably going to get 5% in six months. But 100% of your principal is at risk. I don’t think 5% justifies the risk,” he said.

The stock is up by a third so far this year. At 32%, its implied volatility is two times higher than the average for the market.

“This is crazy volatile, crazy overvalued. That stock has been overpriced for years. Even when it fell back in Christmas, I still think it was overpriced,” he said.

Between July 2018 and December, the share price fell by 44% while the S&P 500 index lost about 20%.

“It’s more of a fad than it is an investment in my view.”

American barrier

Just as concerning for this adviser was the type of barrier used for the principal repayment if the notes are not automatically called.

While the contingent protection allows for a 43% drop in the share price without putting the capital at risk, it can be breached at any time. These types of triggers, also known as “American barriers,” are less common than the typical “European barrier,” which is observed only once, at maturity.

“It adds a huge element of risk and uncertainty. Any stock can go to zero. Could Netflix drop 50% in 15 months? You’d better believe it could,” he said.

Risks

Kalscheur tried to imagine which types of investors may find the notes appealing.

“The only people who are going to buy this note are people who are in love with Netflix. Maybe they own the stock and want to use it as a hedge.”

This view would be limited to a range-bound market.

“You can’t be a huge bull obviously, otherwise why the 10% cap? You can’t be a huge bear either,” he said.

Income investors of course would be likely to benefit from the product with the double-digit contingent coupon. But income investors usually need safety.

“I still think there are better options out there, securities that do not represent such high level of risk,” he said.

“Our primary reason to buy structured notes is for the downside protection.”

Although the notes feature a barrier, the American option behind the trigger and the high volatility of the underlying did not qualify as downside protection, he said.

In addition, the call feature generated reinvestment risk, which was another drawback.

The valuation of the underlying was also an issue.

“It would make more sense to buy something like that during or just after a sell-off. You would get at least a margin of safety and probably a higher coupon. But even in those circumstances, the capped return is not going to compensate you for the risk you’re taking.”

Autocalls on market

Finally, this adviser said the cost of the structure was too high.

“2¼% fee for 15 months! ... That’s ridiculous,” he said.

“Other than the good credit of Credit Suisse, I don’t see any good reason to buy this note, at least for us.”

Kalscheur, who buys structured notes on a regular basis, said he is not unfamiliar with or opposed to autocallable payouts.

“We’ve done some, but we do them on indices. Even a worst-of on two indices is better for us. You may not have that low barrier, but you’re diversified across hundreds of stocks.”

If the idea of a single-stock underlying was probably the main concern, the pick itself was also a negative.

“This is a media company that has very large competitors. Yes, they did phenomenally well for the past seven years. But a lot of it is hype, and we think the stock is way overvalued.”

Moving parts

Steven Foldes, vice-chairman at Evensky & Katz/Foldes Financial Wealth Management, was not showing any enthusiasm either.

“It’s a complex strategy. For a firm that does strictly mutual funds and ETFs, individual stocks are completely out of the question,” he said.

“The level of complexity is high with respect to getting your coupon, certain barriers, being called.”

Finally, he said autocallable notes fail to match the rules and criteria his firm has put in place to manage clients’ accounts.

Not right match

“Whether we allocate to growth or to capital preservation, we always look for strategies that allow investors to express a strong view but with additional features, for instance a buffer or a digital coupon providing a minimum return. This note does not match those criteria,” he said.

Foldes is particularly interested in digital coupon notes with uncapped upside and downside protection.

“They provide a minimum return if the market is flat. If it’s up, you still participate in the upside. The downside protection means that you achieve a low correlation to the stock market. Depending on the underlying, its valuation and its volatility, these types of products may fit into our growth bucket or alternatively in our capital preservation bucket.”

The Netflix-linked product exhibits just the opposite features: the upside is capped, and the capital is fully at risk, he added.

“I can see why people would do those deals for income. It’s just not the right fit for our asset allocation model.”

Credit Suisse Securities (USA) LLC is the agent.

The notes will price on Thursday.

The Cusip number is 22549JQ37.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.