Credit Suisse’s notes on S&P, Dow offer uncapped leverage, but barrier size is debatable

By Emma Trincal

New York, May 24 – Credit Suisse AG, London Branch’s $3.35 million of 0% accelerated barrier notes due May 21, 2025 linked to the S&P 500 index and the Dow Jones industrial average offer uncapped leverage over a three-year period only. But advisers had different views regarding the barrier strength as a hedge in a down market.

If each index finishes at or above its initial level, the payout at maturity will be par plus 138.85% of the return of the worst performing index, according to a 424B2 filing with the Securities and Exchange Commission.

If any index falls but each index finishes at or above the 80% knock-in level, the payout will be par.

Otherwise, investors will be fully exposed to the decline of the worst performing index from its initial level.

Don’t lose money

Kirk Chisholm, wealth manager and principal at Innovative Advisory Group, was not impressed by the downside protection.

“Unless there is a serious protection, I wouldn’t be interested in these kinds of deals in the environment we’re in, in this bear market,” he said.

“Right now, I’m more concerned about capital preservation than how I may increase my returns.”

Not in a buying mood

The S&P 500 index is down 17.3% from its high in January. On Friday, it fell by 20% on an intraday basis, nearing a bear market. The Dow Jones industrial average has shed 13.5% this year.

This adviser was skeptical about the “buy-the-dips” philosophy.

“I know some people feel very confident to get in this market since stock prices are lower. With the sell-off, they think they’re getting some kind of a bargain. To them, if we’re already down for the year that’s a good reason to jump in and take advantage of the lower entry points.

“But these are the people who think the market will always go up. They tend to ignore the lessons of past bear markets. Look at what happened in the 1970s or early 2000s. You had much more serious declines than 20%. It looks that we’re heading into that direction now.

“If some want to bet the market will recover soon, I’d happily take the other side of the trade,” he said.

No cap

Jonathan Tiemann, president of Tiemann Investment Advisors, said he liked the notes.

“It’s definitely bullish. There is no cap,” he said.

“What you don’t get compared to a long position is the exposure to a single underlying since it’s a worst-of, and you also sacrifice the dividends.

“But you do get the leverage on the upside with no cap, and getting this over a three-year term is not bad.”

One positive aspect of the deal was the choice of the two underlying indexes for the worst-of exposure, he said.

Worst-of

“They’re both U.S. large-cap benchmarks, and they tend to move in the same direction,” he said.

The three-year coefficient of correlation between the S&P 500 index and the Dow is 0.975. A perfect correlation would be 1.

“If you want to be really negative, you can imagine a scenario in which at maturity the S&P drops 20% and the Dow falls by 21%. That would make you tear your hair out,” he said.

“Correlations are not perfect. These indices are calculated in very different ways. The S&P is cap-weighted, the Dow, price-weighted. Also, the Dow only has 30 stocks.”

But the terms of the notes were “fair,” he said.

“You’re being compensated for this worst-of structure and for the loss of the dividend.

“If you’re mildly bullish and seek some protection, it’s not a bad structure,” he said.

Back testing

In his risk assessment, Tiemann said the length of the investment mattered more than current price levels when it comes to evaluating the odds of a barrier breach.

“I don’t necessarily look at an entry point thinking: the market is down 20%, there is no risk. People who do technical analysis will tell you the market is oversold, that kind of stuff. Just because we already experienced a big drawdown does not tell me much in the short run. It could go down more, or it could go down less,” he said.

“But I do look at the fact that it’s a three-year tenor. And on a three-year rolling basis, it would be unusual for those indices to be down more than 20%. It’s certainly possible. But it would be unusual.

“Regardless of whether it makes sense to buy during market sell-offs, historical data and probabilities tell us that over three years, you’re not very likely to see a 20% drop.”

The notes may be used to help skittish investors stay invested, he added.

“I can see how the deal can be marketable. Some people are in the market at all times either by philosophy or by mandate. That type of note with the 20% protection might help,” he said.

“I do sort of like it.

“If it was the S&P and the Nasdaq, it would be a much different deal. But with those two indices, the terms are quite reasonable.”

Credit Suisse Securities (USA) LLC is the agent.

The notes settled on Thursday.

The Cusip number is 22553PXH7.

The fee is 1%.

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