Credit Suisse’s contingent coupon autocalls on three stocks at high end of risk spectrum

By Emma Trincal

New York, Feb. 7 – Credit Suisse AG, London Branch’s contingent coupon autocallable yield notes due Feb. 14, 2022 linked to the common stocks of Amazon.com, Inc., Costco Wholesale Corp. and Lyft, Inc. are designed for aggressive investors willing to take more risk for a higher coupon, said Suzi Hampson, head of research at Future Value Consultants.

If each stock closes at or above the coupon barrier level, 65% of its initial share price, on a quarterly observation date, the notes will pay a contingent payment for that quarter at a rate of 17.10% per year, according to a 424B2 filing with the Securities and Exchange Commission.

The notes will be called at par plus the contingent coupon if each stock closes at or above its initial price, on any quarterly observation date after six months.

If the notes are not called, the payout at maturity will be par unless either stock finishes below the 65% knock-in level, in which case investors will lose 1% for each 1% decline of the laggard stock.

“The coupon is pretty high because you’re getting some significant risk for this type of product,” said Hampson.

“You have exposure to three stocks, not broad indices, and you’re exposed to the worst of the three.

“Sometimes you’ll find worst-of with securities in the same sector. Here we have quite different stocks.”

Correlation

As the stocks belong to different sectors, they’re not highly correlated.

The one-year correlations between the stocks vary from approximately 0.7 to 0.74 depending on the pair.

The less correlated are Costco and Lyft with a coefficient of correlation of 0.69. The most correlated, with a coefficient of 0.74 are Costco and Amazon. Lyft and Amazon show a correlation of 0.71.

“The correlations aren’t bad but they could be higher,” she said.

Discrepancy of performance, which is the main risk associated with worst-of payouts, increases inversely to correlation.

Lyft

Another factor adding risk is volatility.

“Among those stocks, Lyft is particularly volatile,” she said.

Lyft has an implied volatility of 40.4% against 24.1% for Amazon and 18.8% for Costco.

“Lyft has the potential to have the biggest move; it has the potential to trigger the biggest losses.

“When you have a stock as volatile as Lyft, a 35% price move on the downside is not outrageous. As a result, the barrier can breach.”

But the other side of the coin is the return.

“There’s not a super high correlation between the underlying stocks. One is very volatile. The note pays a 17.10% coupon. It gives you an idea of the extra risk you’re taking,” she said.

“You could get a pretty decent coupon with a single-stock as long as the underlying is volatile. But adding the worst-of introduces even more premium.”

A recently priced UBS AG, London Branch two-year autocallable linked to Lyft alone showed a 10.06% annual contingent coupon based on a 60% coupon barrier. The notes are automatically called on the first quarterly review date. The principal-repayment barrier at maturity is 60%.

While this note offers a 5% deeper barrier, the terms are relatively similar. Yet the 10% coupon is much lower.

“A worst-of will boost the coupon significantly,” she said.

“The combination of all those risk factors gives you a 17% yield. That’s pretty high.

“You wouldn’t expect a low-risk kind of product with that type of headline rate.”

Scorecard

Future Value Consultants provides stress-testing reports on structured notes delivering Monte Carlo simulation tables and back-testing analysis. Hampson analyzed the results produced by the report she ran on the notes.

Each report contains tests based on five distribution assumption sets.

The neutral scenario is the basis of the simulation in all reports, reflecting standard options pricing.

The other four distributions are market scenarios – bull, bear, less volatile and more volatile – based on growth assumptions.

Call protection

Hampson focused on one of the 29 tables displayed in each report called the “scorecard.” It shows the probabilities of mutually exclusive outcomes under the neutral scenario.

She first looked at the call outcomes which displayed in seven rows or “call points.” The first call point is six set months after the trade date and shows the highest probability at 31.17%.

“You’ll always be more likely to kick out on the first date,” she said.

“But 31% is a much lower probability than the 50% we typically see for first call on average.

This is due to the six-month call protection, she explained.

“It’s a good thing for investors who know that a call at point 1 will give them half and not a quarter of the annual return,” she said.

But skipping the first quarter also lowers the probabilities of a call occurring at the first call date.

“The more data points you have, the greater the probabilities of calling so that’s one factor. The other is that you’ll be further away from the initial price in six months than you would be after three,” she said.

“If you don’t call, your capital is increasingly at risk.

“Again, this shouldn’t be surprising. The 17% coupon is quite high. You’re not going to get that for free.”

Capital loss

These elements help increase the likelihood of losing capital, one of the outcomes displayed on the scorecard under the header “total return loss.”

The probability associated to this outcome in the neutral scenario is 26.6%.

“It’s a total return loss, which means that it takes into account the coupons already paid to you,” she said.

How much loss? The table revealed an average loss of 40.1%.

“We already know that if the final price hits the barrier, investors will lose at least 35%. The 40% is the average only within the capital loss outcome.”

“But it’s quite large,” she said.

Market assumptions

These scorecard’s probabilities are based on the neutral scenario. Results vary when the simulation runs other market assumptions.

For instance, under the bull scenario, the barrier breach event will happen 18.21% of the time.

The lower probability is easy to understand.

“In a bull market you would expect these stocks to go up even though you could still end up below the barrier,” she said.

On the other hand, losing money will happen 36.95% of the time under the bear scenario.

“The bear is starting to look pretty bad,” she said.

In conclusion, Hampson said the notes were fairly risky for an autocallable product.

“It’s definitely an aggressive product. But owning the shares would be riskier,” she said.

“For reasonably bullish investors at least, you get a decent coupon and the benefit of the barrier.”

As always, it all boils down to investors’ tolerance for risk and their market outlook.

Credit Suisse Securities (USA) LLC is the agent.

The notes will settle on Feb. 14.

The Cusip is 22551NP34.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.