Credit Suisse's worst-of notes linked to S&P 500, Russell offer deep barrier but complex risk

By Emma Trincal

New York, Aug. 1 - Credit Suisse AG, Nassau Branch's 0% cert plus securities due Sept. 5, 2017 linked to the S&P 500 index and the Russell 2000 index offer bullish investors an opportunity to outperform equity markets with a deep barrier and uncapped leveraged upside as long as they are comfortable with the "worst-of" payout, sources said.

The payout at maturity will be par plus the underlying return of the lowest-performing index, according to a 424B2 filing with the Securities and Exchange Commission.

If an index's final level is greater than or equal to its initial level, its underlying return will be 135% to 140% of the index return. The exact upside participation rate will be set at pricing.

If an index's final level is less than its initial level and a knock-in event occurs, that index's underlying return will be equal to its decline. A knock-in event occurs if the final level of either index is less than or equal to 50% of its initial level.

If an index's final level is less than its initial level and a knock-in event does not occur, that index's underlying return will be zero.

Deep protection

Despite the worst-of payout, the notes are "interesting" for their level of downside protection, said Steve Doucette, financial adviser at Proctor Financial.

While it takes only one index to trigger the knock-in event and both indexes to get the benefits of the upside payout - which is uncapped leverage - Doucette said that he still liked the notes.

"This protection is quite significant. It makes this deal a little different," he said.

"With a 50% downside protection, you're outperforming the market as long as none of the two indexes drop by more than 50%. It's a pretty impressive protection level. Theoretically, if the worst index is down 10% or 30%, you're outperforming by a long shot.

"Then you have the uncapped leveraged upside. You're outperforming on the upside too.

"That's not bad."

The tenor of the product was more of a concern than the payout, he said.

"I might play with the duration a little bit and try to shorten it," he said.

"The four-year [tenor], however, is not necessarily a bad thing. If you have a bear cycle followed by a bull, you could have the market down in the beginning and then move back up.

"Without trying to time the market, I may look at where we are now in the cycle.

"But looking at the overall structure, I like the note the way it is.

"The only thing I may want to change is the duration, so I would have to look at how to adjust the other parameters. If I wanted a three year for instance, I may have to get 1.2 times leverage instead of 1.4, the protection level may have to change or a cap may come into play.

"But I find this 50% level interesting. Small caps may come down harder than large caps, and so the Russell would be more likely to breach it. But still, 50% is a pretty good barrier."

Multiple risks

Matt Medeiros, president and chief executive of the Institute for Wealth Management, said that he was not comfortable with the added risk associated with multiple underliers.

He said that he was uncomfortable with managing a risk exposure tied to one or another index instead of being mitigated and diversified across different basket constituents.

"Your return is not tied to the average of the two indexes with one positive return potentially offsetting a negative one," he said.

"Instead, your risk is tied to each index individually within one security. As a result, if one index does very well while the other performs poorly, your return is tied to the worst. It's not as if the gains of one would reduce or eliminate the losses of the other.

"My preference goes to a single underlier in general. If I need multiple exposure, my preference is to own different notes tied to one index each.

"But if I have to have multiple securities in a structured product, I prefer to get the basket type of return. I'm more comfortable with the return of the underlying constituents that comprise the basket. With a note tied to a basket, I get the average or weighted average of the index components.

"From a risk management perspective, it's much better to monitor the exposure with one underlying basket or one single underlier as opposed to tracking one underlier versus another in the same portfolio."

Having the return tied to the worst-performing index was not the main drawback, he explained. Even a product whose return would derive from the best performance of several underliers would be problematic from the standpoint of risk management, he added.

"When you have the best of or the worst of, the risk becomes difficult to manage.

"If you're dealing with different components for the return and you have to put that in the context of your overall portfolio management, it makes it complicated to manage and understand the risk.

"The challenge I have with this particular note is that although I like both asset classes independently, I would find it difficult and time-consuming to try to determine what the potential outcome would be.

"Too many moving parts here."

Credit Suisse Securities (USA) LLC is the agent.

The notes are expected to price Aug. 30 and settle Sept. 4.

The Cusip number is 22547Q6K7.

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