Credit Suisse’s notes tied to Dow, Russell show rare use of a worst-of in a leveraged trade

By Emma Trincal

New York, June 7 – Credit Suisse AG, London branch’s 0% accelerated barrier notes due June 30, 2022 linked to the Dow Jones industrial average and the Russell 2000 index bring a worst-of option into the plain-vanilla leveraged return product, something that is not often seen, a market participant said.

If each index finishes at or above its initial level, the payout at maturity will be par plus 140% to 150% of the gain of the worse performing index, according to a 424B2 filed with the Securities and Exchange Commission.

If either index falls but finishes at or above the 50% knock-in level, the payout will be par.

Otherwise, investors will lose 1% for each 1% decline of the worse performing index.

Worst-of on leverage

The deal is “unusual” because most leveraged notes are constructed around one underlying or are based on a basket of securities, this market participant noted.

Whenever worst-of structures are employed, it is generally to provide income.

“There is no coupon. You get upside participation and in this case uncapped upside participation. It’s kind of unusual,” he said.

“Normally worst-of are used for contingency.”

He meant that the majority of worst-of payouts are found in contingent coupon notes, which are for the most part also autocallables, but not in return enhancement notes.

“I’ll give you this coupon if the worst index is above a certain level. I’ll call the note if the worst underlier is above initial price. That’s a worst-of.

“People use worst-of to bump up yield, not for participation.”

Just because the use of these options in a leveraged structure is relatively uncommon does not mean it is not an interesting idea, he added.

“I think it’s good. There is no logical reason not to put a worst-of option in a growth product. You can certainly do it, and I’m not sure why people aren’t doing it more.”

The worst-of payout cheapens the cost of the option, allowing the issuer to offer more attractive terms, he said.

With these notes, the use of the worst-of may have contributed to structure an uncapped upside return.

“I’m not saying that whenever you use a worst-of you can eliminate the cap, but it helps. I tend to think that it happened here probably because an investor wanted a no-cap deal and so they structured it that way,” he said.

Correlation

The use of two relatively correlated benchmarks was a risk-limiting factor, he said.

“Putting together the Russell and the Hang Seng for instance would raise the odds of losing money. But it would also give you better terms,” he said.

“These two U.S. equity indices are highly correlated. It helps or it doesn’t help the investor depending on whether you care more about risk or about return.”

The use of the Dow Jones industrial average and the Russell 2000 was pretty standard, he noted, as it combined two U.S. equity benchmarks, one for the large-cap universe and the other for small-cap equity, while providing a pretty high correlation between the two.

“The S&P is more common than the Dow, but there’s nothing exceptional here. Generally investors may have a harder time accepting worst-of with two uncorrelated assets. Clients are not dumb.”

Terms

An industry source said he liked almost everything about the deal except its length.

“In all this stuff, time is your friend,” he said.

“You’re giving up some liquidity for tying up your money for five years. At the same time you’re getting 50% more than what the market is going to give you.

“The 50% barrier is great. If one of these indices is down 50% we’ve got bigger problems, especially in five years.

“I also like the no cap. I get to put my bull hat on.”

And yet, he said he would probably not buy this type of note.

“It’s a five year. That’s a long time...at least for me.

“It’s an attractive deal. But one has to be cognizant of the liquidity implications,” he said.

Credit Suisse Securities (USA) LLC is the agent.

The notes will price on June 27 and settle on June 30.

The Cusip number is 22550B6L2.

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