Credit Suisse's high/low coupon notes tied to S&P, Russell, Brazil ETF fit range-bound bet

By Emma Trincal

New York, May 11 - Credit Suisse AG, Nassau Branch's upcoming high/low coupon callable yield notes due May 29, 2012 linked to the S&P 500 index, the Russell 2000 index and the iShares MSCI Brazil index fund are designed for moderately bullish investors willing to adopt a risky structure in exchange for above-average returns, sources said.

"This is for a moderately bullish investor who doesn't see a bear market coming up," said Andrew Pool, main trader at Regatta Research & Money Management.

A knock-in event will occur if any underlying component closes at or below 72.5% of its initial level, according to a 424B2 filing with the Securities and Exchange Commission.

Interest is payable quarterly. The coupon will be 11.6% per year unless a knock-in event occurs, in which case the coupon will be 3% per year for that and each subsequent quarter.

The payout at maturity will be par unless a knock-in event has occurred, in which case the payout will be par plus the return of the lowest-performing component, subject to a maximum payout of par.

Range bound

"This is not the structure you want if you're strongly bullish or strongly bearish. This is definitely a range-bound strategy," said Pool.

"The coupon is very attractive," he added, "and there is a market view behind this deal."

Pool said that the market has "run up" since 2009 and that several factors indicate a possible "moderation for the returns in stocks," such as the "evaporation" of quantitative easing and the rise of interest rates looking forward.

"You might expect a moderation of growth without necessarily a crash. This is the market view this structure is trying to monetize," Pool said.

Brazilian beta

Risk, however, is aggravated by the choice of the Brazil fund as one of the three underlying components, sources said.

"The 25% decline can easily happen with Brazil just in two months," a sellsider said.

"I would be disinclined to invest in this note because of Brazil," said Pool. "I would think that Brazil, as an emerging market, may increase the opportunities for a knock-out."

Pool said that selling pressures are mounting in the emerging markets space. He cited several factors: "China is tightening to cool down its economy. The commodities trade is very crowded. The end of QE2 is coming soon. The dollar is oversold. And you have potential problems in Europe."

A feature in the structure allows investors to keep on earning interest even if the knock-out event occurs but at a lower rate, according to the prospectus.

The total amount of interest paid will depend on when the knock-out occurs between the settlement date and the maturity date, noted Pool.

"I like this feature. ... It reduces the risk from an investment standpoint," he said.

Yet, the trader said that he was still "concerned" about Brazil.

"With a high beta index on Brazil, you may have an asymmetric outcome. I would have exchanged a lower coupon for a higher knock-out level," he said.

Another reason to be cautious about the Brazil component, Pool said, was currency exchange risk. Because the Brazil index fund is denominated in dollars, any appreciation of the dollar against the Brazilian real would negatively impact the value of the index fund, he explained.

Structure's bad name

Some said that they did not like the worse-of structure represented in this deal as it only takes one among the three underlying components to trigger a knock-out event.

"Why do investors do it? It's to get more coupon. For issuers, it's a little bit more complicated because you have to structure a barrier around three different assets," the sellsider said.

"The less correlated the assets are, the better it is for the issuer as it increases the chances of a knock-out.

"I personally find those worse-ofs structures extremely toxic."

But a New York-based structurer disagreed.

"Worse ofs are not bad deals. No deal is bad as long as you disclose what it is. It's not new, by the way. This technique has been around for about 10 years," he said.

He compared the structure of this product with a reverse convertible linked to a single stock or index.

"It's a little bit more complicated than a reverse convertible. The difference is that with several underlying components, you have more probabilities to lose money. So you have to get money for it. With that comes a higher coupon. A worse-of will pay you a higher coupon than a reverse convertible," he said.

This structurer said that worse-of deals were not in essence "toxic" as there is a rationale behind the structure.

"With a worse-of you're increasing the chances of loss and in turn, you get a higher coupon if you don't lose. It's a fair game," he said.

Lack of correlation between the underlying components is a risk factor to take into account, he said, as well as a potential higher source of return.

"The less correlated the underlying indexes are, the more chances you have to lose, so the bank will give you a higher coupon," he noted.

In this deal, the structurer said that large caps and small caps as represented by the S&P 500 index and the Russell 2000 index respectively were "highly correlated." On the other hand, there was less correlation between the Brazilian fund and the two U.S. stock benchmarks.

The notes (Cusip: 22546E6V1) are callable at par on any interest payment date beginning on Nov. 29, 2011 and are expected to price on May 24.

Credit Suisse Securities (USA) LLC is the underwriter.

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