Credit Suisse’s buffered, uncapped notes tied to S&P 500 have no leverage, but tenor is short

By Emma Trincal

New York, Nov. 30 – Credit Suisse AG, London Branch’s 0% buffered return equity securities due July 3, 2018 linked to the S&P 500 index give investors a chance to get exposure to the equity benchmark with a buffer and no upside limitation, noted a financial adviser.

In exchange, investors only have one-to-one upside participation, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to the buffer amount and will lose 1% for each 1% decline beyond this amount, which is expected to be between 10% and 15%.

“This deal offers an interesting trade-off,” said Michael Kalscheur, financial adviser at Castle Wealth Advisors.

“Usually if you want leverage, you have to get a cap. This one has no cap. It has no leverage, but it’s only a two-and-a-half-year.

“And also when you want a good buffer you have to go longer term. This one is a short-term deal.

“So you have a real buffer on a short period and no cap. That’s excellent.”

Simplicity

Kalscheur examined the note based on his routine approach, namely credit risk, underlying type and structure simplicity.

“On the credit risk scale, Credit Suisse may be on the upper tier, but we still would consider it. They’ve got a good presence in the structured note arena,” he said.

“The structure is straightforward. You don’t have many moving pieces.

“Everyone knows the S&P 500 index. The whole thing is easy to understand.

“This looks like it would be the perfect opportunity for someone who wants to dip their toe into structured investing.

“It’s a simple, straightforward, plain-vanilla product which would be a perfect offering for a client who is not familiar with structured notes.”

Term, fee

Kalscheur pointed to the short tenor and relatively low fee as some of the most attractive features.

“We get a little bit of pushback from clients on the four-, five- or six-year range. They wonder if they’re adequately compensated for those long holding periods. Here it’s a two-and-a-half-year. It’s not even half of a business cycle. It’s really short,” he said.

The fee is 1.25%, according to the prospectus.

“I’m always going to push this number down for my clients, but obviously 1.25% is very fair. Anything around half a percent a year is very competitive.”

Buffer

The description of the buffer in the prospectus may be a source of frustration for some clients.

“There’s a huge difference between 10% and 15%. Usually it’s the cap that’s put in a range. Some people may throw a bigger fit over not knowing the buffer. But the mere fact that it’s a buffer is really good,” he said.

Using historical data on the S&P 500, Kalscheur predicted that the risk of a decline beyond 10% – if one considers the lower end of the buffer range – is very small.

“We’ve compiled this data back to 1950. What we found is that in the last 65 years, the chance for the S&P to be down 10% or more over a two-and-a-half-year period is only 10.7%. Basically, 90% of the time, the index is not going to drop more than 10%, which means that the buffer will work for you. You’re going to get some decent protection.”

The profit outcome was more difficult to assess. The notes are not levered and investors do not receive dividends, he noted.

Investors would have to give up a 5% return over the life of the notes based on the 2% dividend yield that the S&P 500 index offers.

“If the index is up a lot, I’m going to trail due to the dividends but not by a huge amount,” he said.

“It’s mostly if the market goes nowhere that I’m paying a higher price for not getting the dividends.

“So that would be the worst-case scenario. ... The market is flat and the only way to make money is with the dividends; in that case, the note is not giving you the best outcome.”

Tax consequences

Kalscheur pointed to the tax treatment of the product.

“It’s not detrimental, but you do have to look at the way it’s taxed. ... [Y]our principal is not 100% at risk. You have 15% that’s guaranteed. The result is a chance that you may not fall into the capital gains category. You may have to pay income tax to the IRS based on some hypothetical yield each year.

“I can tell you that investors are not going to be happy if they get a tax bill for an income that hasn’t been paid out.

“Other than that, it’s an excellent offering.

“It’s definitely something we would consider adding to our repertoire.

“It’s short-term, easy to understand, the fees are competitive.”

No dividends

A trader had a different view, arguing that the protection was in reality quite limited.

“I’m betting that the S&P will be up. If I’m wrong, I get my first 15% protected. Why would I do that? I don’t have any upside advantage. In fact, I lose 5% in dividends,” said this trader.

He revalued the real amount of downside protection based on a hypothetical 15% buffer.

“For the downside, I could get a 5% protection if I had the dividends, so my 15% buffer is in reality only a 10% buffer. Plus you would have to factor in the cost of pricing the buffer, deducting the fee, etc.,” he said.

“I could buy an at-the-money put at 100 and be protected all the way down to zero rather than having 85% of my money at risk. Again, I’m not sure why would anyone do that.”

Buy a put instead

“I guess this is for someone who doesn’t want to take the first 15% losses, but if the index is down 30%, you lose 15%” he said.

“If the market is down 10%, you don’t lose, but you’ve lost the 5% dividends to pay for the buffer. It took 5% to pay for this.

“So really you only have 10% in downside protection.”

Buying an at-the-money put (which would be a put protecting the entire investment from any loss) would cost a premium that might be expensive, he said. But a fair comparison would have to take into accounts fees and commissions in both trades, he added.

“At least when being long a put I’m fully protected. What’s the upside to this note?

“If I’m bullish, I’m going to buy the S&P and I’m going to buy a put. I can buy an at-the-money put, which is more expensive, or a put at 85, so I would get 85% of my principal protected.

“With this I have 85% at risk.

“I don’t understand it because most people can withstand a 10% or even a 15% loss. It’s the 80% loss that people worry about.”

Credit Suisse Securities (USA) LLC is the agent.

The notes are expected to price on Dec. 31 and settle on Jan. 6.

The buffer amount will be set at pricing.

The Cusip number is 22546VR65.

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