Credit Suisse's Bares with 20% buffer linked to Dow receive above-average return, price scores

By Emma Trincal

New York, April 11 - Credit Suisse AG, London Branch's 0% Buffered Accelerated Return Equity Securities due July 31, 2019 linked to the Dow Jones industrial average combine a bonus payout, uncapped upside participation and a sizable buffer, giving investors the means to outperform the benchmark in a competitively priced structure, said Suzi Hampson, structured products analyst at Future Value Consultants.

If the index finishes at or above the initial level, the payout at maturity will be par plus the greater of the index return and a fixed payment of 15% to 20%. The exact cap will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 20% and lose 1% for every 1% that the index declines beyond 20%.

Digital type

The notes fit into the digital category in Future Value Consultants' methodology.

The category enables the research firm to compare the product to similarly structured notes when assigning scores.

"Usually digital products are a little bit shorter than this five-year [note], and it makes pricing more difficult, so it's rare when the issuer offers something with no cap. What enables them to get rid of the cap here is the longer term. In general, either you get a shorter maturity with a cap or a longer-dated note without any cap. These are usually the two types you can find," Hampson said.

"This product is longer. Investors are holding the notes for a little bit more than five years. It gives the issuer more to play with when putting the structure together. The uncapped participation is quite attractive, especially over a longer period of time when the cap can be off-putting."

Payout

The upside can be broken down into two parts, she noted.

"Let's suppose the digital payout is going to be 18%. Any index gain below that level will boost your return to 18%. If the index is up 1%, you will get 18%. You can substantially outperform the index depending on how far the final index level is from the digital level," she said.

The second component of the payout is the 100% participation paid when the index finishes above the digital level.

"You get one-to-one on top of it. Unlike many digitals, which also are caps, your upside is not limited," she said.

Finally, on the downside, the structure offers a "generous buffer" of 20%, she said.

"You lose 1% for each 1% of index decline below the 20% threshold, which means that your maximum loss is 80%," she said.

"It means that in a downside scenario, you are better off than buying the index outright."

Investors have several ways to outperform the benchmark, she added.

"You can beat the market if there is a decline as a result of the buffer. You can also outperform if the market is up moderately because of the digital. Finally, the one-to-one upside participation on top of the digital is the equivalent of being long the index, so while you won't outperform here, you wouldn't be penalized by a cap," she said.

"One caveat though: investors do not get paid dividends.

"It's pretty much understood when one invests in structured notes that dividends are not going to be part of the payout. However, this is a five-year term. With a 2.13% dividend yield, the amount of dividends investors have to forgo is substantial.

"Definitely the non-payment of dividends has to come into the picture when evaluating the notes, especially if you're a bullish investor expecting to earn the one-to-one upside. That's something to think about. If the term was only one year, it would be entirely different."

Cautiously bullish

Investors buying the notes should have a market view that coincides with the type of payout that is the most likely to outperform the index, she observed.

"Where this product is really going to outperform is with the digital payment," she said.

"Therefore an investor needs to have a bullish attitude. You can only get a return if the index is positive, so obviously, this is not for bears.

"But it's not for very bullish investors either. You probably should believe that market gains will be subdued because that's when you can benefit the most from the digital payment.

"If you anticipate a strong run, your best bet would be to invest directly in the index and not in the notes as they would not pay you any dividends.

"Investors in these notes have to be bullish but mildly bullish and cautiously bullish. They're bullish because they don't anticipate stock prices to fall. But their attitude about risk is rather conservative. The bigger buffer is aimed at people who also want to protect themselves against market risk."

Low market risk

According to Future Value Consultants' measure of risk, the notes successfully mitigate market risk.

Future Value Consultants measures the key metrics of risk, return and price via its proprietary scores.

One of the most important scores is the riskmap, which consists of the sum of market risk and credit risk. The riskmap is measured on a scale of zero to with 10 as the highest level of risk possible.

The notes' 1.86 market riskmap is better than the 2.47 average score for products of the same type, according to Future Value Consultants' research report.

"The buffer plays a big part in that. Also within the digital category, you have many products that are tied to either single stocks or more volatile underlying benchmarks than the Dow. This too reduces the market risk in comparison with similar products," she said.

In terms of credit risk, the notes show a 0.67 credit riskmap, which is on par with the 0.64 average.

"I am somewhat surprised by this result. We know that this product's maturity is longer than average, so I would have expected the credit riskmap to be above the average of its peers, which it is not. It's just average," she said. But she said that the most likely explanation is the issuer's creditworthiness.

The five-year credit default swap spread for Credit Suisse is 62 basis points. In comparison, the CDS spreads for Citigroup, Bank of America and Morgan Stanley are 78 bps, 79 bps and 83 bps, respectively.

"It's quite possible that the better credit profile of this issuer is counteracting the duration effect," she said.

Adding credit and market riskmaps, the report shows a riskmap for this product that is "much lower" than the average digital note.

The notes have a 2.53 riskmap versus 3.11 for the average, the report showed.

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.

The return score for the notes is 8.37. The average for digital products is 7.44.

"This score gives us a risk-adjusted return. Given the amount of risk they're taking, investors are well-compensated. That's what the high score suggests. The fact that the product's return score is almost one point above average shows that the structure offers a competitive return compared with other products in this category," she said.

"One reason for that is that there is no cap. The best scenario used to compute the score of this product is bullish. Over as five-year period and with no cap, you could get a pretty decent return."

Probability tables

With its probability chart, Future Value Consultants estimates how the product is expected to perform under the five key assumptions. It assigns a probability of return outcome to each of the payoff buckets. The chart is generated using a Monte Carlo simulation using various parameters such as volatility, dividends and interest rates.

With the bullish market assumption, there is an 87% probability of a positive outcome against a 13% probability of losses.

"If you put together the above-average buffer size, the uncapped upside and the bonus payment, you get a structure that's quite attractive," she said.

Price score

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.

The average price score for the digital category of product is 7.64. In comparison, the notes' price score is 8.69.

"A lot of the time, price score and return score move together," she said.

"If the issuer spends a lot of money in buying the assets, in other words, if they spend a lot on the options used to structure the notes, you would expect a good return score. So in general, if the price score is high, the return score is also going to be high.

"There could be exceptions of course. For example, you could have the case of an issuer spending all the money in a bond without creating a structure that pays much. But in general, spending money in the assets will improve the terms and will work to the advantage of the investor in terms of risk-reward.

"It's not always true the other way around. A good return score does not always mean that the price score is high.

"In this case, the price score is also above the average by one point. It suggests that they spent a good amount of money in the options in order to give investors the uncapped return and the bonus payment."

Overall score

Finally, the overall score measures Future Value Consultants' general opinion on the quality of a deal. The score is the average of the price score and the return score.

The notes have an 8.53 overall score versus an average score of 7.54 for products of the same type.

"Price score and return score are both one point above average. Naturally you get an overall score that beats the average by one point," she said.

"The note is performing very well across various indicators. The market risk is below average. The pricing is good. The risk-reward profile is very attractive. This is definitely a competitive product. If you compare it with its peers in the digital notes category, it looks like a very decent offering."

Credit Suisse Securities (USA) LLC is the underwriter.

The notes will price April 28 and settle April 30.

The Cusip number is 22547QLM6.

© 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.