Time is key when choosing between two upcoming Credit Suisse deals, sources say

By Emma Trincal

New York, Jan. 12 – When picking one deal among two with similar features – same issuer, underlying and downside protection – the tenor played as much of a role as the payout type, sources said.

Credit Suisse AG, London Branch announced the pricing of two short-dated notes tied to the S&P 500 index each of which providing full principal protection.

The first one is a 13-month digital product paying 9% at maturity if the index is flat or positive. The notes mature on Feb. 29, 2024.

The second deal is a leveraged note due Jan. 31, 2025, which pays 1.5 times any index gain and is capped at 21%.

No income

Howard Simons, president of Rosewood Trading, stressed the importance of opportunity cost.

“The first one, the 13-month digital note, spares you the premium you would pay in buying a call option, but in exchange, you incur the opportunity cost of not earning short-term rates,” he said.

“If the market goes down, you get zero as opposed to holding cash with interest.”

For instance, an investor holding $1,000 in short-term bonds and money market instruments would get a return from his cash allocation.

“But if I buy the note and the market goes down, I get nothing.

“There’s an opportunity cost to capital,” he said.

The same opportunity cost applied to the leveraged note capped at 21%. None of the two notes offered any income payment.

Shorter is better

However, Simons would be more inclined to purchase the digital note over the leveraged one based on the shorter term of the former.

“I would go for the 13-month rather than the two-year because two years is a longer timeframe to be exposed to the credit risk of Credit Suisse, which as we know is not zero,” he said.

The Zurich-based bank has incurred steep losses and its share price is down two-thirds from its high of a year ago.

Amid negative headlines, clients have pulled funds out of the bank, which is engaged in a restructuring process. As a result, the cost of insuring Credit Suisse’s debt as skyrocketed, as measured by credit default swap rates.

On Thursday, the five-year CDS rate of the bank was 385 basis points, according to S&P Global Market Intelligence. In comparison the CDS spreads of UBS were 73 bps. BNP Paribas and Deutsche Bank, two other European banks, showed CDS rates of 59 bps and 114 bps, respectively.

Winning with cash

Simons then compared holding the notes with having a long position in the index fund.

“If you buy the index, you get the full upside, you don’t have the credit risk. These are the benefits of equity. But you’re exposed to potential losses,” he said.

“We don’t know what the market is going to be over the next 13 months or two years. A year ago, everyone knew that the Federal Reserve was going to raise rates. But I don’t think anybody had any idea they would be as aggressive as they turned out to be.

“Cash ended up being the best performing part of the portfolio.”

Digital versus leverage

Between the two notes, Simons said he preferred the 13-month with the digital payout.

“It’s shorter. That’s an advantage. Another advantage is that I’m going to get my 9% even if the S&P is flat. The market doesn’t have to go up,” he said.

In contrast the S&P 500 index has to increase at a rate of 6.77% a year in order for the two-year leveraged note to reach the 21% cap, which is the equivalent of a 10% compounded annualized return.

The cap on the leveraged product was not high enough compared to the digital return to incite investors to give up the benefit of a “booster,” he said.

In addition, there was more “upside risk” over a longer term.

“If we come out of this sell-off, I could easily make more than 21% in two years,” he said.

“With that two-year note, you’re locking yourself in for too long and for too low a cap.”

Bearish tilt

Steve Doucette, financial adviser at Proctor Financial, compared the two structures based on which of the two was the most likely to outperform the market.

“They’re both attractive because of the principal-protection component. You’re obviously more bearish. Can you predict what the market will be like 13 or 24 months from now? That’s the hard part,” he said.

The digital note would underperform if the S&P 500 index closed above 9% at the end of the 13-month period, he said.

“If that’s your view, you’re leaning on the bearish side. You’ll outperform if the index is negative or if it’s flat or slightly above par. Your best-case scenario is if the market is hardly up at all,” he said.

Missing less upside

For Doucette, the digital note offered the best potential for outperformance.

“There’s a lot more uncertainty in the equity market over 13 months than two years. The S&P is down 20% from its high of last year. It’s bound to recover but how long will it take?” he said.

While markets can recover quickly, the chance of a bigger upward move is greater over two years than 13 months, he said.

“You’re less likely to miss on the upside over the shorter period of time, which is why, if my goal is to outperform the market, I would go for the 13 months.”

Comparing the two different caps, Doucette noticed that the difference was negligeable between the two products. A more important factor was the amount of index appreciation required to achieve the maximum gain.

Leveraging in vain

“The leveraged note can give you 10% a year, which is not too bad. But the market needs to go up. It’s got to be up 7% a year before you cap out. That’s a risk,” he said.

Leverage is not helpful in a sluggish market, he added.

“Even with three- or four-times leverage, if the market is up only 1%, what do you care? This happened to us in the past. The digital is better in that regard because you get paid as long as the market isn’t negative,” he said.

Time horizon

Overall, the main flaw common to both products was the significant amount of upside investors had to give up in order for the issuer to price the principal protection.

For both market participants, the digital notes offered the best structure, at least for risk-averse investors.

“If I take that bearish stance, it’s the first deal that I would choose,” said Doucette.

“But I’m not really bearish.

“You’re limited by the short maturities. I would probably go two or three years out and see what I can get.”

Credit Suisse Securities (USA) LLC is the agent.

Both deals will price on Jan. 26 and settle on Jan. 31.

The Cusip number for the digital notes is 22553QPW1.

The Cusip number for the leveraged return notes is 22553QPY7.

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