Credit Suisse’s contingent autocall reverse convertibles on stocks seen as risky for income play

By Emma Trincal

New York, Nov. 17 – Credit Suisse AG, London Branch’s contingent coupon autocallable reverse convertible securities due Nov. 24, 2021 linked to the least performing of Apple Inc. and Target Corp. present too much risk on the downside given the high valuation of both underlying stocks, financial advisers said.

Interest is payable quarterly at an annual rate of at least 12% if each stock closes above its coupon barrier, 70% of its initial level, on the related observation date, according to an FWP filing with the Securities and Exchange Commission. The exact coupon rate will be set at pricing.

The notes will be called at par if the shares of the least performing stock close at or above their initial price on any quarterly trigger observation date.

The payout at maturity will be par unless either of the stocks finishes below its 70% knock-in level, in which case investors will receive a number of shares of the least performing stock equal to $1,000 divided by the initial share price or, at the issuer’s option, an amount in cash equal to the value of those shares.

High performance

Michael Kalscheur, financial adviser at Castle Wealth Advisors, said he usually prefers notes linked to broad indexes.

“Unless the underlying is exactly the stock you want to buy, we don’t really use individual stocks for our structured notes, so this wouldn’t be a good fit for our clientele,” he said.

Both stocks have outperformed the market, he noted.

Target posted a five-year compounded rate of return of 19.5%.

“It’s not like Target has been a slacker, but Apple’s five-year trailing return is 34.09%,” he said.

“Either way, they both beat the 14.28% return of the S&P.”

Big recovery stories

Both stocks have also posted an impressive recovery performance since their respective lows of last spring.

Target for instance has gained 81% since its early April low. Apple despite the March bear market is up 63% for the year.

“I usually don’t give recommendations for single stocks, at least for structured notes purposes. But if I need information, I’ll check the Morningstar ratings. I think they do a good job at assessing the current value of a stock,” he said.

Above fair value

Apple has a fair value of 85, according to Morningstar.

Based on its $119.39 closing price on Tuesday, the barrier would be hit at a price of 83.6, he noted.

“The barrier is below what Morningstar thinks it’s worth. I don’t feel that 30% is going to give me all that much protection. I think Apple is overvalued,” he said.

“It’s been going up too far, too fast.

“I would be extremely nervous about a 30% protection especially since it’s just a barrier, not a buffer.”

Separately, Morningstar set a fair value price for Target at 107. The stock closed at $163.04 on Tuesday.

“If Morningstar thinks Target’s fair value is 107, the stock is overvalued at 52%.

“It doesn’t give me much confidence either.”

The barrier level would be 114.

“That barrier is actually slightly higher than what Morningstar considers fair value. Not a good sign,” he said.

“Now Morningstar is not a panacea. But they’re a respected company that has a solid methodology on how to value a stock.”

Another sign giving this adviser pause was the fact that both stocks dropped 30% this year during the spring sell-off.

One-year tenor

“If we have a terrorist attack, if the vaccine doesn’t work or cause other problems, you can easily see another 30% from the levels we’re at,” he said.

The short tenor was also a concern.

“On a five-year, I would be more comfortable taking that bet based on this structure. But a one-year makes any prediction more difficult. It makes me nervous,” he said.

The chances of getting automatically called reduced some of the risk, he conceded. But for an income-oriented product, Kalscheur said he would rather use indexes than single stocks.

Indexes alternative

He mentioned a one-year Morgan Stanley worst-of note linked to the worst of the S&P 500 index, the Russell 2000 index and the Nasdaq-100 index. The barriers both for the coupon and at maturity are also at 70% of the initial price. The contingent coupon is between 6.5% and 8.5%.

“You get paid less but it’s on three broad-based indices, which are much more correlated to one another.

“You have a lot less volatility. I see this as more suitable for an income play,” he said.

The implied volatility of Apple and Target is 33% and 38%, respectively. Target will report its third-quarter earnings on Wednesday before the open. The stock could move significantly either up or down depending on the outcome.

Apple and Target have a weak correlation to one another, which is another risk factor. Their coefficient of correlation is 0.583 compared to 0.987 for instance between the Dow Jones industrial average and the S&P 500. Less or negatively correlated underliers can more easily post diverging performances, hence the risk.

“If you’re going to get called out, why take the risk of two individual stocks?” he said.

“Especially two overvalued stocks.

“There is too much downside risk based on these valuations. I would take a pass on this deal.”

Credit, fee, dividends

Steven Foldes, vice-chairman at Evensky & Katz / Foldes Financial Wealth Management, also expressed concerns regarding the risk of breaching the barrier due to current price levels. He noted however that he liked the creditworthiness of the issuer.

“The fee is a little bit high for a one-year note, which is only paying 12%. On top of that you’re not getting paid the dividends so that’s a potential 1.65% yield you’re giving up,” he said.

The fee for the notes is 1.25%, according to the prospectus.

Target has a dividend yield of 1.65%. Apple yields 0.68%.

Barrier level

“Not only are you only getting 12%, but it’s a contingent coupon. The worst-of makes it challenging to get that coupon on a consistent basis,” he added.

“You could end up with a big problem if one of the two stocks breaches that barrier at maturity. That would be a loss of at least 30%. During the sell-off last spring, we’ve seen that they both could drop 30% or more. And now the stocks are trading near the high of their ranges. Apple has more than doubled since March.”

Too rich

The rich valuation was reflected in the price-per-earnings ratios of 36.83 for Apple and 23.8 for Target compared to 20.43 for the S&P 500 index.

“A 37% P/E is really expensive,” he said.

“The fact that you’re only getting 12% with no dividends and you’re not getting it upfront but quarter by quarter assuming you stay above that 70% barrier is not very appealing.

Uncertainty ahead

“Clearly the environment for the market is better than two weeks ago because we had an election that presumably has been settled.

“We have not one but two vaccines, which is why we’re hitting new record highs on the S&P and the Dow.”

In an upbeat situation, things can change rapidly, he said.

“It could be geopolitical or political, or related to Covid-19. We don’t know,” he said.

“On a risk-return basis, this is too much risk for not enough reward, especially for an income note.

“This is not something I would recommend to my clients.”

Credit Suisse Securities (USA) LLC is the agent.

The notes will price on Thursday and settle on Nov. 24.

The Cusip number is 22550MLT4.

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