Credit Suisse’s 19.75%-20.25% autocall revcon on stocks fails to impress conservative advisers

By Emma Trincal

New York, April 16 – Credit Suisse AG, London Branch’s 19.75% to 20.25% autocallable reverse convertible securities due April 30, 2019 linked to the least performing of the common stocks of Cleveland-Cliffs Inc., Transocean Ltd. and United States Steel Corp. illustrate how issuers are able to recreate the traditional reverse convertible known for their high and fixed coupon despite adverse market conditions.

With rates still low and market volatility still below its long-term average, linking a note to a volatile single stock no longer offers enough premium. But combining an autocallable feature and a worst-of payout will do.

As always, those short-term, highly rewarding products involve risks. Advisers expressed caution when looking at the notes.

Interest is payable monthly, with the exact coupon to be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par if each stock closes at or above its initial level on any quarterly trigger observation date.

The payout at maturity will be par unless any stock finishes below its 65% knock-in level, in which case investors will receive a number of shares of the worst performing stock equal to $1,000 divided by the initial share price or, at the issuer’s option, the cash equivalent.

Market risk

Advisors were awed by the coupon size. But a glance at the call risk and market risk at maturity led them to lose interest in the deal.

“The 20% is very exciting. But you have to look at the risk/reward,” said Carl Kunhardt, wealth adviser at Quest Capital Management.

“The best you can do is 20%. But you can lose 100% of your principal. Use the coupon as a cushion and you’ve lost 80%. When you’re talking risk versus reward, you have to balance it off. I don’t know how you can spin losing that much money as your risk for a 20% return even though it’s a very exciting coupon,” he said.

One reason to be concerned about the risk of losing principal at maturity despite the barrier was the choice of the stocks. Two of the companies, Cleveland-Cliffs, an iron ore mining company, and United Steel, a fabricator of structural steel, belong to the basic materials sector.

“They’re screening for the tariffs,” he said, referring to president Donald Trump’s tariffs on steel and aluminum.

“I don’t know the stocks. But I can imagine one at least being pretty volatile.”

The implied volatility of Cleveland-Cliffs and United States Steel are very high at 58% and 62% respectively.

Oil and gas driller Transocean is an energy stock. It is the least volatile of the trio with a 48% volatility.

“It takes one stock to breach 35% on that last day and the whole thing falls apart,” Kunhardt said.

“You’re rolling the dice on this thing.”

Call risk

The risk of losing some principal at maturity was one aspect of the overall risk associated with the product, he said. This scenario at least would be the most rewarding since it is the only way by which investors have a chance to capture the full 20% coupon.

“I liked the deal up to the point where I heard the word autocall,” he said.

“Without the call, I found it interesting. You had this huge coupon, which you can always use as a buffer if things turn out against you,” he said.

“But the 20% is a distraction because you won’t make it to a year. You’ll be called before that.”

Likely call

Michael Kalscheur, financial adviser at Castle Wealth Advisors, said he would not buy the notes simply because he sticks to large, well-known equity indexes or blue chip stocks such as Fortune 500 companies.

“I suppose this note was designed for a specific client with an exposure to these stocks, a client with specific needs,” he said.

Kalscheur said the coupon payment was very attractive but improbable.

“It’s an interesting idea. Wow! There’s a 20% return for the year. Well, realistically, the chances of making it all the way to maturity are very slim.

“It’s possible. After all, you have three stocks.

“But you can get called every month after the first quarter. If the market moves straight up you’ll be called up.”

Due diligence

Kalscheur said he is not a stock-picker.

“This type of deal requires spending time doing your due diligence on the stocks just to get comfortable with the structure. We don’t go out of our way to do research on stocks that are not already well-known. We’re too small. It puts us at a disadvantage for these kinds of deals,” he said.

Transocean

Yet, Kalscheur had some idea about the underlying stocks.

“I know Transocean very well. Back in 2007-08 they were unstoppable. It’s a deep-water drilling company.

The share price peaked in 2007 at $180.00. The stock is currently trading at $11.85.

“This stock has been decimated. Fracking has become the dominant form of drilling and it completely changed the game,” he said.

U.S. Steel

U.S. Steel did not have bright prospects either, according to Kalscheur.

“The uncertainty is extreme, according to Morningstar,” he said referring to the research firm’s uncertainty ratings, which assess a range of possible fair values.

Trading today at $35.75 a share, the stock price fell 81% from its $185.00 peak in June 2008.

Cleveland-Cliffs

Finally looking at Cleveland-Cliffs Kalscheur said: “I’ve never heard of these guys.”

The stock, which peaked in 2008 at $122.00 a share, hit bottom in 2015 at $1.42.

“It’s a drop of 98.8% in seven years. It’s hard to lose that much,” he said. The stock is now trading at $6.80.

“We’re talking about a stock that’s been put through the wringer in the last decade. The question is: is that all done or is there more pain in the future?” The stock closed at $6.78 on Monday.

Due diligence, worst-of

Kalscheur said he would not consider the notes.

“I don’t know the stocks well enough to show this to a client. With this deal, you have to do the research on the stocks or have a client willing to take the risk.”

Kalscheur prioritizes his preferences.

“We use broad indexes. I don’t have to do any due diligence on the S&P 500. I know what I’m buying and our clients know what they’re buying. Spending time researching stocks is impossible for a small shop.”

In addition, the type of structure was difficult to explain to a client.

“We manage our clients’ expectations. It’s nice to show them a 20% coupon. But then you have to explain the deal. Hey, we’re going to buy a structured note; it’s going to be based on three individual stocks; and you’re going to get the worst of the three,” he said.

Cost

Another negative for this adviser was the cost of the deal. The fee can be as high as 2.875%, according to the prospectus.

“That’s crazy high. Especially for one year,” he said, adding that his maximum is 1% for one year.

“It’s an interesting structure. I’m sure someone will like it. It just doesn’t work for us.

“Super high risk... high volatility... super high cost and short-term tenor...all the extremes that go against our ethos.”

“You know that you’re going to make 5% after three months and that’s great. After that you have no idea of how much money you’re going to make or lose quite frankly.”

Credit Suisse Securities (USA) LLC is the agent.

The notes will price on April 26.

The Cusip number is 22549JB33.

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