Credit Suisse’s 10%-12% autocall reverse convertibles linked to Facebook may need coupon boost

By Emma Trincal

New York, Sept. 12 – Credit Suisse AG’s 10% to 12% autocallable reverse convertible securities due Oct. 1, 2015 linked to the class A shares of Facebook, Inc. offer a fixed coupon and a “decent” barrier, but given the high volatility of the stock, the risk-adjusted return score assigned to this product suggests that the issuer “should perhaps have been looking at a higher coupon,” said Tim Mortimer, managing director at Future Value Consultants.

Interest will be payable monthly, according to a 424B2 filing with the Securities and Exchange Commission.

A knock-in event will occur if the stock closes at or below the knock-in level, 70% of the initial share price, on any trading day during the life of the notes.

The notes will be called at par plus accrued interest if the stock closes at or above the initial share price on March 27, 2015 or June 26, 2015.

If the notes are not called and a knock-in event does not occur, or if it does but the final share price is greater than or equal to the initial share price, the payout at maturity will be par.

If a knock-in event occurs and the final share price is less than the initial price, investors will receive a number of shares of Facebook stock equal to $1,000 divided by the initial share price or, at the issuer’s option, an amount in cash equal to the value of those shares.

Fixed coupon

“This is some sort of hybrid between a standard autocallable and a revers convertible,” Mortimer said, adding that those products fall into the “review reverse convertible” category based on his firm’s methodology.

The note is different from a “straight reverse convertible” because it has a call feature, and it also differs from a traditional autocallable because it has a fixed coupon, he explained.

The product is designed for income, he said, and the category to which it belongs has implications on the amount of return investors should expect.

“There are strong relations between an autocallable like this and a reverse convertible. They both pay a fixed coupon. If you had a standard autocall, your yield would be much higher because you would only get paid when the note gets called. You would be compensated for the risk of not getting your coupon,” he said.

“With this particular autocall, you get paid monthly. If the notes are not called, you are still paid a coupon.

“These notes have one characteristic in common with a straight reverse convertible, which is the fixed interest rate. But the important difference is the call feature. With this product, you get two chances – six months and nine months from the pricing date – to get your capital back, whereas for the reverse convertible, it’s at the end.”

Call and market risk

The autocall can reduce the risk associated with the product, but at the same time, risk is enhanced by the underlying stock, which has a high level of volatility at 41%, he noted

“The fact that they’re giving you two chances of getting your money back given the volatility of the stock makes this autocall feature very valuable. In some ways, it’s a mechanism that reduces the overall risk because obviously once you’re called, your principal is no longer at risk,” he said.

“You have a 30% contingent protection, but it’s through an American barrier ... a barrier that can be breached any time during the life of the notes. Those barriers are less protective than those observed at maturity. So the risk picture is mixed. From a risk standpoint, you’re better off being called.”

The key metrics of value, return and risk are measured through various scores established by Future Value Consultants. The research methodology generates reports designed to assess the quality of a product compared to the rest of the market.

Value

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10. This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

The notes received a 4.61 price score, compared with an average score of 6.47 for review reverse convertibles, according to Future Value Consultants’ research report.

“The price score suggests you should be looking at a better coupon,” he said.

Return score

Future Value Consultants measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions: neutral assumption, bull and bear markets and high- and low-volatility environments.

The return score is calculated based on the best among the five return scenarios, which for this particular product would be bullish.

The notes have a 5.48 return score, compared with an average score of 6.14 for products of the same type.

“The return score is better than the price score. When this happens, it generally indicates that you’re getting a decent protection. That’s because the return score takes into account potential bad returns. We know that the chances of losing a lot of money would be reflected in the return score,” he said.

Market risk

Future Value Consultants measures risk with its riskmap rating on a scale of zero to 10 with 10 as the highest level of risk possible. The rating is the sum of two risk components: market risk and credit risk.

The market risk associated with the product is relatively high, he noted. It received a 5.09 market riskmap, compared with an average score of 3.17 for products of the same type.

“The protection level appears to be decent, and yet we have some market risk, which can be attributed to the very high volatility of the stock. Facebook is a stock we see regularly in the offerings. It’s a hot stock and moves rapidly, which is why the options pay a higher premium. But of course there is some risk associated with a stock that can move so widely either way,” he said.

“This is quite a short trade, and it’s based on a volatile stock. So this leads to a higher market risk as volatility increases the chances of breaching the barrier anytime.

“You have to be some sort of a stock-picker to buy these notes or at least have a strong opinion on the company. If you believe that 30% is enough protection, you’re still getting a lot of value in the coupon.”

Overall score

The notes received an overall score of 5.04, compared with a 6.31 average score for this type of product, the report showed.

The overall score measures Future Value Consultants’ general opinion on the quality of a deal by simply averaging the price score and the return score.

“This note is for an investor who wants income and who is prepared to take some risk on Facebook,” he said.

“If you were to buy the stock outright, you would participate in the upside, but you would have no protection and no coupon.

“It’s got to be for someone who is familiar with the stock and comfortable with the risk level. If not, these types of products can be dangerous for investors. That’s why you had so many problems with reverse convertibles in the post-dot-com era.”

Credit Suisse Securities (USA) LLC is the agent.

The notes will price Sept. 26 and settle Oct. 1.

The exact terms will be set at pricing.

The Cusip number is 22547QTB2.

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