Credit Suisse's 90% protected notes linked to currencies aimed at risk-averse dollar bears

By Emma Trincal

New York, July 5 - Credit Suisse AG, Nassau Branch's 0% notes due July 31, 2014 linked to a basket of four currencies are designed for investors who believe that the U.S. dollar will continue to fall over the next three years but who need a strong level of downside protection to take that bet, sources said.

The underlying currencies are the Australian dollar, the Brazilian real, the Canadian dollar and the Norwegian krone, according to a 424B2 filing with the Securities and Exchange Commission. The currencies are equally weighted.

The payout at maturity will be par plus 1.3 times to 1.4 times any basket gain. The exact leverage will be set at pricing.

Investors will be exposed to losses of up to 10%. The minimum payout is 90% of par.

A macro view

Mark McCormick, currency strategist at Brown Brothers Harriman, said that he is bearish on the U.S. dollar.

"Our view is that we're sill looking for broad-base dollar weakness," he said.

"If your fundamental outlook is that the dollar will continue to be weak, this type of option-like strategy is a very good way to express it. We agree with this view."

McCormick said that he does not expect the Fed to raise interest rates anytime soon, which would make the currencies that constitute the underlying basket all the more attractive.

"Most other central banks are moving at a pace of normalization, but with the posture the Fed is taking now and the fact that it is likely to alter its balance sheet, we don't expect any rates hikes before the second half of 2012 if not the beginning of 2013," he said.

Despite the ending of QE2, McCormick does not anticipate a rates increase and believes the Fed is likely to unwind its balance sheet in a way that will continue to support Treasuries, pushing rates downward.

"They will reinvest their [mortgage-backed securities] portfolio into Treasuries," he said.

Another factor of softness for the dollar is the weakness of the U.S. economy compared to other developed countries, including those represented in the basket, McCormick noted.

"The fundamentals of the U.S. economy lead us to anticipate a larger output gap between the U.S. and these countries, which will work to the advantage of their currencies," he said.

"These are high-growth economies, high-beta currencies that are going to outperform when risk assets are doing well."

Conservative players

The notes target conservative investors who need a fair amount of principal protection.

The high level of downside protection - investors may not lose more than 10% of their principal subject to credit risk - appealed to some financial advisers.

"This is very nice. We like the substantial principal protection," said Frederick Wright, partner and chief investment officer at Smith & Howard Wealth Management.

"And we like the concept. We call those notes 'BANC'-linked notes for Brazil, Australia, Norway and Canada. In fact we bought a very similar note last year and were able to get better terms.

"We feel the dollar will continue to weaken because of the budget deficit and the accommodative monetary policy. So far it has worked well for us.

"In addition, we're bullish on those four currencies because those countries tend to be rich in natural resources."

Wright said that he bought in March 19, 2010 some of Deutsche Bank AG, London Branch's $1.1 million of zero-coupon 95% principal-protected notes due March 25, 2013 linked to the same basket of currencies.

The payout at maturity will be par plus 1.75 times any basket appreciation relative to the U.S. dollar. Investors are exposed to any basket depreciation, subject to a minimum payout of 95% of par.

Competitive protection

"We find it very attractive to have principal protection of 95% or 90% range," said Wright. "I don't see it very often.

"In equities, it's very rare. You may get to see substantial protection levels like that in equities for a three-year [note], but you're not going to get near that upside.

"The only way you could get that type of payout in a similar three-year equity note would be off the shelf maybe."

A currency-linked notes trader said, "You couldn't do a 100% protection on a three-year. But with a 90% protection, three-year is not uncommon."

Data compiled by Prospect News for the first half of the year shows that almost all equity-linked notes with 90% or 95% principal protection have a tenor of five or six years. In contrast, currency-linked notes with the same type of protection have a two-year duration on average.

Another advantage of the structure is the fact that it combines leverage on the upside without a cap. One way to price it, the trader said, is by lowering the cost of buying an option by selling another one.

The trader explained that the principal protection of 90% is obtained by selling a put spread.

"You buy and sell an option. So a portion of your cost is offset by the premium that you get. You only look at the net," he said.

The issuer creates the leverage by buying a call, he added.

Credit Suisse Securities (USA) LLC is the agent.

The notes will price July 22 and settle July 29.

The Cusip number is 22546TBR1.

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