Credit Suisse's $2 million notes tied to Apple offer innovative put, absolute return payout

By Emma Trincal

New York, Dec. 13 - Credit Suisse in a tiny offering introduced two features sources said were worth paying attention to. They pointed to a put option the investor can exercise during three observation dates, getting an early redemption paying a premium that increases with the trigger price, and secondly, an absolute return payout slightly different than usual with a low barrier.

Credit Suisse AG, Nassau Branch priced $2 million of 0% absolute return barrier securities due Jan. 13, 2014 linked to the common stock of Apple Inc., according to a 424B2 filing with the Securities and Exchange Commission.

A trigger event occurs if the closing price of Apple stock is greater than or equal to the trigger price on a review date. The trigger price is 104% of the initial share price on April 10, 108% of the initial price on Aug. 8, 2013 and 112% of the initial price on Dec. 10, 2013.

If a trigger event occurs on any review date, the securities are putable at par plus an early redemption premium. The premium is 4% for the first review date, 8% for the second date and 12% for the third.

A knock-in event occurs if Apple stock closes below the knock-in price on any day during the life of the notes. The knock-in price is 63% of the initial share price.

If the stock finishes at or above the initial price, the payout at maturity will be par plus the gain, up to a maximum return of 13.6%.

If the stock finishes below the initial price and a knock-in event has not occurred, the payout will be par plus 40% times the absolute value of the stock return.

Otherwise, investors will receive par plus the stock return with full exposure to losses.

To put or not to put

Sources said that giving investors the choice to exercise or not the put option on three observation dates was an attractive feature that provided always-welcome liquidity. At the same time, the mechanism was seen as complex as the choice itself required the timing to be right.

A structurer said that he saw triggers for calls or autocalls before, but not for puts at the discretion of the investor.

"For private clients, it seems rather complex. I assume an institution did it. Even if it's only $2 million, it could have just been for a portion of their portfolio.

"What is less clear to me is why would you choose to put the notes to the issuer if the stock price was higher than the trigger price," he said.

He gave the following example, occurring on April 10, 2013, on the first observation date. On that day, he assumed that the stock price would be 106% based on the initial 100% price, or a 6% appreciation. The price is above the 104% trigger price yet the investor opts for the early redemption, getting his money back and pocketing the 4% premium.

"Why would you choose the early redemption with the 4% premium when the stock is up 6% at that point?" asked the structurer.

There could be several reasons, he explained.

"You may anticipate the stock to decline.

"You also have the 13.6% cap working against you.

"Another explanation may be found with secondary pricing. Suppose the market price of the stock is at 106% but the bid price is 103%. If the investor can put it at 104%, they'll get 1% more than the bid. But you have to forfeit the 2% difference between the premium and the current stock price."

That type of decision, he said, would be nearly impossible for an individual investor to make.

"To decide if it's economically and mathematically justified to put the product is extremely complex. You need to know what the forward is doing, when the dividend is being paid and a few other things.

"I don't know anybody who would do that except for an institutional investor. That's why my guess is that Credit Suisse sold it to someone like a pension fund for instance. Even if it's only $2 million, it could have just been a simple allocation to the portfolio," he said.

Market timing

Steve Doucette, financial adviser at Proctor Financial, saw the put option as some form of a hedge for an investor whose view would be primarily bearish.

"You can't get more than 13.6% on the upside. Why would you call it if the stock is higher than the trigger? On the downside, you can make as much as 37%. Ultimately, this note has a bearish bias in my opinion. The only value in this note is if Apple goes down," he said.

If anything, the putability made the notes more enticing for traders than for investors, Doucette said.

"It's capped at 13.6%. Why would you buy this other than to play quarterly trading? It's not an investment vehicle. Instead you're making a call on a very volatile stock. And no one really has any idea where the stock price of Apple is heading.

"They leave it up to you to decide when or if you want to exit early. It's an awfully difficult decision to make.

"That's why I think it's more like a market-timing and market-trading decision," he said.

However for investors who believe that Apple's bull run may be over, the product looks more like an investment, but one with a bearish bias, he said.

"If the stock is down, you'll significantly outperform as long as you don't break through that knock-in," he added.

"I see this more of as a bearish trade or at least a product for people who aren't super bullish on the stock.

"If you believe Apple is not going to be the best thing since sliced bread, that may work, but if you don't, choose another trade and don't cap yourself," he said.

Hands on management

For Matt Medeiros, president and chief executive at the Institute for Wealth Management, the put mechanism introduced a lot of value in the product, giving the investor or portfolio manager more liquidity and more control.

"You have several put options in this deal at different valuation points," Medeiros said.

"It gives the investor the opportunity to evaluate the product at different points in time. If your opinion has changed, if tax laws have changed, if the rules have changed, you have an opportunity to reassess. This early redemption mechanism introduces more hands-on management.

"The terms aren't so difficult to understand. It's just that you have different decision points. It's not complicated. It's just management," he said.

Absolute fraction

Another unusual twist in the structure consisted in limiting the amount of absolute return potential gain to 40% of the amount of stock decline.

"The absolute return provision is nice even though it's factored down," Doucette said in reference to the 0.4 times factor that limits the amount of absolute return performance.

The prospectus offered an example, assuming no early redemption. In the example, Apple shares finished down 20% and no knock-in event occurred during the life of the notes. The investor may receive in this case 40% of the absolute value of the 20% decline in the stock value, or 8% in return.

Most absolute return structures, also called two-win or dual directional notes, give investors the full absolute value of the percentage decline providing that the underlying closes above the threshold, observed the structurer.

However, this product gives more room for return on the downside - up to 37% - than on the upside, limited to the 13.6% cap, he added.

"Instead of getting 100% of the absolute value of the decline, you're getting only 40% of it. I assume they did it that way because they didn't have enough money to buy the down-and-out puts," he said.

For Medeiros, the 0.4 factor reduced the value of the absolute return. But it had to be analyzed in the light of 63% barrier level, which he said was attractively low.

"I don't find it overly penalizing given the 37% range that you have for the absolute return," he said.

"I like the absolute return feature in itself. It's fair to spread the risk between the issuer and the investor. With a stock of this nature, which had such a wonderful run, to have the opportunity to participate in the downside on an absolute return basis is attractive."

As long as the investor understands the product, the structure has a lot of potential, the structurer said, adding that the exercise of the put is perhaps what's the most problematic.

"Besides the complexity of the deal and the difficulty in making the put decision, this product makes sense for an institutional investor," he said.

"Say you're a pension. You have to beat the benchmark. You'd be very happy if Apple dropped by 20% and you got 8%. You'd beat the stock. If you're bearish, you have the option to put the stock at some point.

"It's attractive, but whether it's worthwhile to put it or not remains very complicated to determine," he said.

Credit Suisse Securities (USA) LLC was the underwriter.

The notes (Cusip: 22546TN80) priced on Monday.

The fees were 1.5%.

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