Credit Suisse’s trigger jump notes on Euro Stoxx Banks show sector bet with too much risk

By Emma Trincal

New York, Dec. 18 – Credit Suisse AG, London Branch’s 0% trigger jump securities due July 2, 2020 linked to the Euro Stoxx Banks index had advisers focus more on the underlying index, which they said was too volatile for their taste and less on a structure, which may have been compelling if used on a more diversified, less risky index.

If the Euro Stoxx Banks index finishes at or above its initial level, the payout at maturity will equal par of $10 plus the upside payment, which is expected to be 32.1% and will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 20% and will lose 1% for each 1% decline of the index from its initial level if it finishes below the 80% knock-in level.

Volatile index

The Euro Stoxx Banks index is a free-float market capitalization index that includes 25 stocks of banking sector leaders from 11 euro zone countries, according to the prospectus.

The index is in bear market territory this year having declined by 31%. Last year, it was up more than 14%. The index has been flat or negative three years in a row in 2014, 2015 and 2016.

“The performance of this index is so volatile...it’s very much like a roll of the dice,” said Donald McCoy, financial adviser at Planners Financial Services.

The volatility of the index was particularly visible during the financial crisis years. In 2008, it plunged 62% but jumped back up 52% the very next year. The volatility persisted during the following years. In 2011, the index dropped 35% in the midst of the European sovereign debt crisis but recovered the next year and ended up 31% for the year 2013.

“The inherent volatility of this index shows that you can easily be down more than 20% and possibly up more than 32%,” said McCoy.

“Therefore, you can breach the barrier and lose money quite quickly.”

Euro zone dangers

This adviser was not interested in the underlying investment theme either.

“I don’t feel particularly good about European banks as a sector,” he said.

The euro zone in general showed little to be excited about. The region’s economic slowdown combined with recent geopolitical concerns contributed to a rather negative outlook.

“The current climate we’re in is worse in Europe where there’s already a lot of risk. We’re still not sure what’s going to happen with Brexit. You look at Italy. They’re pushing their budget further than the Union would like to see it go.”

He mentioned the protests in France as another sign of fragility in the region.

“People don’t see the benefits of globalization when too much wealth is in too few hands,” he said.

“So you have those riots and protests.

The slowing of growth and the potential impact of tariffs on the European Union was also for this adviser a major source of concern.

The note as a result did not meet the first check mark on his buy-list.

“What need am I trying to fulfill through this note? That’s always my first question,” he said.

“I don’t have an answer to that.

“This index is incredibly volatile. Some of banks in this index have balance sheets problems.

“I wouldn’t be putting money on this index even if I were positive on the sector. Therefore, I have no reason to invest in a note that runs off this index. This is a big ‘stay away.’”

Sector play

Steven Foldes, vice-chairman at Evensky & Katz / Foldes Financial Wealth Management, shared the same concerns.

His first objection to the index was its scope. Foldes in general prefers to invest in diversified, broad-based benchmarks, staying away from sectors and single names.

“If this structure was applied to the Euro Stoxx 50, I would look at it in a very different way. The Euro Stoxx 50 has been beaten up. But I believe in reversion to the mean. I can see the Euro Stoxx 50 rebounding in 18 months,” he said.

“I can’t say the same with this one.

“It doesn’t look like it’s about to bounce back with a vengeance any time soon.”

Not a value bet

While some may see value in cheap assets or securities, Foldes strongly disagreed.

“This is a sector bet, I would say: almost a gamble. I don’t see any value in this underlying,” he said.

“The banks in this index are credit-challenged. These are institutions that are not all that sound,” he said.

One way to assess the risk associated with the index components is through credit default swaps.

CDS spreads represent the cost to obtain insurance contracts against the risk of default of a bank.

As the risk or perceived risk increases, the cost of insuring the bonds of a bank widens.

The five-year CDS spreads of some of the banks whose stocks are among the top holding in the index are significantly higher than their U.S. counterparts, he noted.

For instance, Italian bank Intesa Sanpaolo SpA, the fourth largest component in the index with an 8.34% weighting, showed CDS spreads of 181 basis points, and UniCredit SpA, another Italian bank whose weighting in the index is close to 6%, exhibited CDS spreads of 178 bps, according to Markit.

Deutsche Bank AG with a nearly 4% weighting had CDS spreads of 188 bps.

In the United States, spreads for the top banks range from 95 bps for the widest (Goldman Sachs) to 59 bps for the tightest (JPMorgan), according to Markit.

“Value goes hand in hand with quality. I don’t see this index as a value play,” Foldes said.

Dividends, terms

Another problem with the notes was the high amount of dividends holders would have to give up.

The Euro Stoxx Banks index showed a high dividend yield of 4.32%.

“You’re giving up about 6.5% more over the term. That’s another negative,” Foldes said.

Moreover, the 2.5% fee was too high in his view.

On the positive side, he said he was comfortable with the issuer’s creditworthiness.

The terms of the structure were compelling enough, including the short tenor and the 20% contingent protection.

The upside was perhaps the most eye-catching term.

“It has a very handsome, if not seductive coupon of 32% over the term.

“But given the risks of losses associated with these European institutions, it makes it very difficult to be bullish enough to even want to take advantage of this coupon,” he said.

Credit Suisse Securities (USA) LLC is the agent, with Morgan Stanley Smith Barney LLC handling distribution.

The notes (Cusip: 22549Y156) will price on Dec. 28 and settle on Jan. 4.

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