Credit Suisse’s contingent coupon autocall on two ETFs bear risk of housing market sell-off

By Emma Trincal

New York, Sept. 25 – Credit Suisse AG, London Branch’s contingent coupon autocallable reverse convertible securities due Sept. 28, 2021 linked to the least performing of the SPDR S&P Homebuilders exchange-traded fund and the Financial Select Sector SPDR fund represent a risky proposition due to the excessively high price of one of the underlying funds, said Steven Jon Kaplan, founder and portfolio manager of True Contrarian Investments.

“The structure is fine, but there is too much downside risk with the homebuilder one. So, you probably should look for a higher return,” he said.

Interest is payable quarterly at an annualized rate of 12.2% if each ETF closes at or above its coupon barrier, 75% of its initial level, on the related observation date, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par if the shares of the least performing fund close at or above its initial price on any quarterly observation date.

If the notes are not called, the payout at maturity will be par unless any ETF finishes below its 75% knock-in level, in which case investors will receive a number of shares of the least performing fund 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.

Overvalued homebuilders

“The homebuilders ETF was at its peak less than two weeks ago. It’s a very popular sector. Home prices have been on a tear during the pandemic, and the move upward is overdone,” he said.

“The financials fund on the other hand is undervalued. I don’t see this asset as posing the greatest risk. The worst-of is probably going to be the homebuilders.”

The notes priced on Sept. 23 with the homebuilders ETF closing at 51.50, a 115% increase from the low of March at 23.95.

“When a security goes up so much in such a short time, the chances of a reversal are exceedingly high. This is not a good entry price,” he said.

A 25% drop from the initial price on the trade date would put the barrier threshold at a price of 38.62.

“The March low was below that,” he noted.

“The barrier would take us back to levels last seen in May, which is not a long time ago.”

Downside risks

The 75% barrier applies to both the coupon and final observation at maturity. Either way, a likely reversal of the ETF bullish trend could adversely impact investors.

“The coupon is at risk. One of the assets is overreaching. You can easily lose money at maturity,” he said.

“While 12% looks like a nice return, it’s probably not enough to compensate you for these risks.”

The best outcome would be for the notes to get called, he added.

“But I wouldn’t count on it,” he said.

Call prospects

The timing of the next two calls – December then March – reduces the odds of a call in his view.

“The next call is the end of the year, a time when assets tend to be cheap,” he said.

“December would have been a better time to price the notes. I wouldn’t expect it to be a time when they would get called.

“We’ve seen a pullback already. But the market hasn’t been down for a long time. It’s been less than a month. The pullback just began.”

The ETF dropped by less than 5% from its peak in the middle of the month.

Kaplan also downplayed the odds of a call in March as he expects the year-end sell-off to be deep.

“Prices will fall at the end of the year, and if they fall a lot, you probably won’t have enough time for a recovery by the end of the first quarter. It may come back but probably not enough,” he said.

No upside breakout

A sign of possible downturn is the inability of the ETF share price to break above its resistance level of 55, he noted.

“You’re more likely to have a breakout on the downside. If it breaks below the 200-days moving average, then it could go to almost any price.”

A resistance level for a long position is a point on a chart which an asset has a difficult time exceeding. It may signal a range bound pattern or a decline.

“You’re increasing your risk when you jump into an asset that’s been going up too far. Homebuilders are overpriced. When things go up so quickly, they can certainly go down,” he said.

“It took less than six months for the fund to go from bottom to top.

“It can certainly take less than a year to drop.”

Excessive speculation

In general, Kaplan tends to be bearish on the market, especially on momentum stocks.

“The options market is overcrowded by individual investors with no trading experience,” he said.

“Like most novices they’re long options, not short.

“We’ve seen records of call options buying, mostly on tech stocks, like Apple and Microsoft.

“While speculation on homebuilders hasn’t been as extreme, prices in the sector are already alarmingly high.”

One hint at troubles ahead is the surging volatility seen in lumber futures.

“Lumber earlier this month hit a record high. It just came down really hard,” he said.

“Anything moving straight up is going to move straight down.

“If lumber prices are any sign, the outlook for homebuilders is pretty bearish.”

Supply and demand

It does not seem that way yet.

Sales of new homes in August rose 43% from last year, according to a report released Thursday by the U.S. Census Bureau.

But the bullish momentum in housing is overextended, he warned.

For one thing, prices are high in part due to a tightening inventory, a situation that creates imbalance between supply and demand, he said.

“Buyers and sellers have to meet somewhere,” he said.

American dream

Another factor has been one of the rare positive results of the Covid-19-induced shutdowns.

“The pandemic has changed people’s expectations about ways to work and live,” he said.

“Many have been working from home. It was a silver lining.

“They bought new homes. They renovated their existing homes. People have been very optimistic about this new stay-at-home trend,” he said.

Mortgage rates

Another factor, also Covid-related, but this time, on the negative side, is the deteriorating job market.

“It’s one thing to hope to live in different places around the country. It’s another thing to be able to afford it.”

Unemployment ultimately will put housing prices under pressure as demand will collapse, he predicted.

“You can’t buy a home when you don’t have income,” he said.

“Millions of people are out of work. The average income in the nation is lower than what it was a year ago. How can you afford to pay for a house?”

Low mortgage rates have offered an answer for some time now. But with demand for loans increasing, the trend of record low mortgage rates is also about to revert, he said.

Inflationary pressures will contribute to that trend as well, pushing mortgage rates on the way up, he predicted.

“The huge fiscal stimulus and the Fed’s tolerance of inflation will soon fuel inflation. Prices will go up. They’ve already begun to go up. And of course, mortgage rates will rise as well.”

Kaplan thinks the “forgotten inflation” is going to reappear in the very near future.

“We’ll already have inflation by the time the notes mature...within one year,” he said.

In this bearish scenario, the correction in the homebuilders sector could be severe.

“It’s an interesting note. But the timing isn’t right,” he said.

Credit Suisse Securities (USA) LLC is the agent.

The notes priced on Sept. 23 and will settle Sept. 28.

The Cusip number is 22550MKJ7.

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