Credit Suisse's basket-linked notes may provide higher cap due to local capping, buffering

By Emma Trincal

New York, Jan. 26 - Credit Suisse AG, Nassau Branch's 0% notes due Feb. 13, 2013 linked to a weighted basket of three buffered return enhanced components allow for a higher maximum return because the capping is "local" - in other words, it is applied at the basket component level to each individual index, a structurer said.

The basket includes the Euro Stoxx 50 index with a 55% weight, the Topix index with a 23% weight and the FTSE 100 index with a 22% weight, according to a 424B2 filing with the Securities and Exchange Commission.

Their underlying currencies are the euro, the Japanese yen and the British pound sterling, respectively.

The payout at maturity will be par plus the basket return, which will be the weighted average of each basket index performance.

Local cap, buffer

Instead of buffering and capping the overall basket return, the structure provides the same cap level and buffer amount applied "locally" to each index.

The composite return for each index will be the underlying return for that index multiplied by the return of that index's underlying currency relative to the dollar.

If an index's average composite return is greater than or equal to zero, its component return will be double the average composite return, subject to a maximum return of at least 20.5% for each index. If the index's average composite return is greater than or equal to negative 10% but less than zero, its component return will be zero. If the index's average composite return is less than negative 10%, its component return will be 1.1111 times the sum of the average composite return plus 10%.

Cap and volatility

"Your cap is 20%. It's probably going to be higher than what you would get if there was just a traditional maximum return capping the basket performance," the structurer said.

"You probably have a higher cap because your cap is local. The performance of an individual index is going to be more volatile than the diversified performance of the basket. With the local cap, there's a pretty high chance that you might hit the cap.

"It's a marketing gimmick. You can get a 20% cap, which looks good, if there is a greater probability to hit that level."

This structurer said that local caps are rather common with certificates of deposit.

"It's the first time I see this type of structure in a note. It's very popular with CDs," he said.

"HSBC, Bank of the West have done many of those in four-, five-, six- or seven-years CDs."

He noted that the underlying used for those market-linked CDs was almost all the time a basket of eight to 12 stocks as opposed to a basket of equity indexes as is the case in this deal.

Leverage versus digital

Another difference with the CDs using local caps, this structurer noted, is the payout structure.

"Usually, it's a digital payout. For each index, if you don't breach the downside threshold, your return gets bumped up to a digital payment," he said.

"I have not seen a payout with leverage like this one.

"People like the digital better than leverage. Here you have two times the performance with a cap. If your index return is 1%, you're only getting 2%. But with a digital, you would get bumped up to the autocap. It's more valuable."

Agnostic trade

For Steve Doucette, financial adviser at Proctor Financial, the product is one of many designed for investors with a moderately bullish view on the market who seek some enhanced yield with some protection.

"This type of deal really reflects the market sentiment lately. I'm not seeing a lot of bulls," Doucette said.

"It's not for bulls because of the cap. And obviously it's not for bears given the downside.

"There a lot of people out there who see a range-bound market, and they just want to collect a little something. Nothing wrong with that. ... It's just a view.

"You want to collect a little bit on the upside if you're slightly bullish, but you're also slightly bearish, so you want some protection too."

One problem, he noted, is the downside leverage factor of 1.111.

"Each index performance is protected against a drop up to 10%. After that, losses get compounded," he said.

"I'm not crazy about leverage on the downside in general. It's a position I don't like to be in."

Doucette said that in this market environment, he can see why investors are reluctant to take directional bets.

While he said he tends to be bullish, he added that betting on a market moving sideways makes sense for many.

"But if I wanted to express that range-bound view, I would probably use one of those absolute value deals, not this one," he said.

He referred to notes that give investors an absolute value payout even if the underlying asset declines at maturity as long as the decline does not breach a particular barrier, which in some cases can be as low as 70% to 60% of the initial level in recent deals.

"Most of those absolute return deals are not leveraged on the downside. They give you a larger cushion. And if you're down but above the barrier, you get a nice absolute value return instead of par. You're outperforming the benchmark a lot more," he said.

The notes (Cusip: 22546TLQ2) are expected to price Friday and settle Wednesday.

J.P. Morgan Securities LLC and JPMorgan Chase Bank, NA are the agents.

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