Credit Suisse’s $3.68 million trigger gears on Russell 2000 offer high upside participation

By Emma Trincal

New York, Aug. 1 – Credit Suisse AG, London Branch’s $3.68 million of 0% capped trigger gears due July 31, 2025 linked to the Russell 2000 index combine high leverage and a “reasonable” cap, making the notes appropriate for investors seeking bullish exposure to small-cap stocks, advisers said. But the very bullish investors may not find the cap high enough in a recovery scenario, said one of them.

The payout at maturity will be par of $10 plus triple any index gain, up to a maximum gain of 43.25%., according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 25% and will be fully exposed to any losses if the index finishes below the 75% downside threshold level.

Upside risk

Chandler Ferguson, wealth adviser at Quest Capital Management, said that the 43.25% cap was “reasonable” but not necessarily adapted to all market conditions.

“I would probably do the notes although I may have a real concern about the upside,” he said.

“Small cap stocks tend to outperform at the end of a recession and three years gives us enough time to work through our current issues such as inflation, negative GDP, etc. By then the market should rebound. Although 43% is not a bad cap for a three-year, you may underperform if a year from now we’re at the start of a new bull market.”

Holders of the notes in such case may find themselves “capped out.”

“It’s not a horrible deal. But if the cap was higher, the leverage would be more attractive. The structure could actually be improved with less leverage and a higher cap,” he said.

“From a timing standpoint, I’m not too excited about the upside. If we enter a new bull market, small caps should lead. I don’t see this happening in the first year, but during the last two years, the Russell is likely to outperform.”

On the other hand, the 25% downside protection was “fairly attractive,” he said.

Overall, the notes offered a defensive strategy with some “reasonable” upside participation.

“The deal is not bad. It depends on the types of clients I would use it for. A retired client who needs Russell exposure would be more likely to buy this structured product than a younger investor in accumulation phase,” he concluded.

Three-year tenor

A financial adviser first expressed concerns with the intermediate term of the notes.

“I may get a bit nervous because statistically, this tenor carries a bit more risk,” he said.

Looking at statistical data on the Russell 2000 index, he said that a 31-month period was the time coinciding with the highest percentage chance of having a 20% loss. A 30% loss was the most likely to happen over a 32-month period, he added.

“That intermediate tenor can be a little tricky,” he said.

But more relevant data came from the frequency of return outcomes, which he used based on the past performance of the Russell 2000 index over three-year rolling periods.

Limited downside risk

“The chances of being down more than 25% are only 3.5% over a three-year period. That’s less than 5% and I use 5% as my bogey. If it’s more than 5% and close to 10%, I’d much rather go for a buffer. But with a 3.5% probability, I’m totally comfortable with the 75% barrier,” he said.

Having a single underlier was also “another nice thing,” he said, not just because it reduced risk but also because it facilitated its assessment.

“When you deal with a worst-of, it’s hard to model the risk since you have to take into account other variables like correlations. Here we only have one index. It’s clear cut,” he said.

High gearing

This adviser liked the upside participation potential of the notes.

The 43.25% cap over three years is the equivalent of a 12.75% annualized compounded return.

“12%, almost 13%, that’s nothing to sneeze at,” he said.

“Not only you get the three-fold multiplier, but the cap is high enough, which gives you a big chance to outperform the index.

“You don’t have to have a strong index performance. Because the leverage is so high, you could hit the cap with a mediocre return,” he said.

Two out of three times

Investors would underperform the index on the upside if the index return exceeded the cap.

“I always want to know what the odds are that I may be leaving money on the table,” he said.

He calculated the chances for investors of seeing their gains cut by the cap using the same back testing approach and found a 27.8% frequency for this outcome.

“27.8% of the time, I will underperform on the upside. That’s not bad at all,” he said.

In order to calculate the probabilities of underperforming both on the downside and on the upside, he added the two different buckets – the 3.5% chance of breaching the barrier and 27.8% chance of being “capped out.”

Overall, the sum of those two negative outcomes revealed a 31.3% frequency.

“That gives me a 68.7% chance of outperforming the market. That’s really good. It meets my main rule which is: if I can win two out of three times, it’s a buy. With this note, I’m even above that.”

The fee

The only negative aspect of the offering was the 2.5% fee as disclosed in the prospectus.

“Even if you divide that by the number of years, it’s still 83 basis points per annum, which is a bit expensive,” he said.

A lower fee would have enhanced the structure even more. But this adviser said he could not complain much as he liked the notes as they were.

“You can’t argue with the terms. Single underlying index; well-known benchmark; great upside participation; very good downside protection,” he said.

“The fee is the fee.

“At the end of the day, if the terms are good, that’s what matters.

“The fee dictates the terms, and the terms drive the yes/no decision-making.

“The terms are really, really good. I’m not not going to buy the notes just because of the fee.”

Small and beautiful

As he “liked the deal a lot,” he said he was stunned by its small size.

“I’m always surprised to see very good deals in tiny sizes like this one compared to huge offerings with terrible terms.”

He gave the example of the commonly sold 14-month Accelerated Return Notes with triple upside exposure.

“No protection, low cap. And yet, banks will get tens of millions of dollars out of those ARNs. I’m always puzzled by that,” he said.

UBS Financial Services Inc. and Credit Suisse Securities (USA) LLC are the agents.

The notes settled on Friday.

The Cusip number is 22552K168.

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