Credit Suisse’s leveraged notes tied to MSCI EAFE use geared buffer to enhance short bull play

By Emma Trincal

New York, June 18 – Credit Suisse AG, London Branch’s 0% leveraged buffered notes linked to the MSCI EAFE index offer attractive terms for a short-dated note, advisers said. Part of the favorable pricing is due to the geared buffer, they noted, finding the feature advantageous as a way to enhance the overall risk-adjusted return.

“You’re getting very good terms for a two-year. You’re handsomely rewarded for taking that geared buffer. Not everyone likes it, but it obviously adds value to the notes,” said Michael Kalscheur, financial adviser at Castle Wealth Advisors.

The tenor is expected to be between 23 and 26 months, according to a 424B2 filing with the Securities and Exchange Commission.

The payout at maturity will be par plus 150% of any gain in the index, capped at 24.57% to 28.89%. The exact cap and maturity date will be set at pricing.

Investors will receive par if the index falls by 15% or less and will lose 1.17641% for every 1% decline beyond 10%.

Tax appeal

The use of the 1.1765 multiple on the downside allows for a 100% loss of principal, Kalscheur noted.

“It scares people. But we see tax-efficiency in it. As we understand it it’s when your full principal is at risk that you can get capital gains exposure, which is very important to a lot of our clients.

Traditional buffers on the other hand often require that a client pay income taxes through the life of the product.

“It’s more risk but you still have a buffer. It would take an astronomical amount of decline to take you down to zero,” he said.

Risk mitigation

Kalscheur uses back testing analysis to assess risk. He has data for two-year trailing periods on the MSCI EAFE index back to 2001.

During that period, the index was down about 26% of the time. The underlier dropped below the buffer only 13% of the time.

“You just cut your risk by half. That’s what the buffer does.

“It’s the most likely half. You’re more likely to be down less than 15% than you are to lose more than 15%.

“You’ll be ahead of the game.”

Analyzing the upside, he found that during any two-year period, the index was below the cap 60% of the time, using a hypothetical cap at midpoint of the range.

“You gain 60% of the time. The other 40% represents the chance that the index would do better than you.

“If you’re a raging bull, the cap is too low,” he said. “But I don’t see a lot of raging bulls anywhere these days unless you’re talking about Seattle real estate.”

Using the 26.75% midpoint for the cap, investors may expect an annual compounded return of 12.6%.

“It’s not huge. But it’s a cap that’s actually realistic and reasonable.

“Having that 1.5x leverage allows you to hit that cap very quickly. It gives you a chance to outperform.”

Kalscheur attributed the attractive terms to the geared buffer.

“These are terms you would expect from a four-year note, and you’re getting it on a two-year.

“The gearing gives you very good terms. And you get this tax treatment, another added benefit.

“I really, really like this offering,” he said.

Middle ground

Carl Kunhardt, wealth adviser at Quest Capital Management, said the notes would be appealing to a mildly bullish investor.

“It all depends on how you feel about this segment of the market. If you feel strongly about it, you don’t want to take the cap. If you’re really bearish, you would want more protection or you wouldn’t want it at all,” he said.

“You have to be somewhere in the middle. It’s all about your outlook on developed countries. For me, the EAFE is pretty much a European index.”

Europe

The MSCI EAFE index has a weighting of about 60% in European equities.

“My view on the notes is going to reflect my opinion on Europe,” he said.

Kunhardt’s view on Europe is mixed.

“They have a number of structural issues. You can’t have the euro without fiscal integration. But they haven’t dealt with it. The solutions are hard and it will keep on coming up and coming up until they do have a solution. So that’s not going to help this market.

“On the other hand, Europe does well when the U.S. economy is strong. They always follow us. If our economy remains strong they will follow us for another 24 months. The caveat: that is unless we get into a trade war and then nobody wins.”

With the buffer and the double-digit cap, the notes are well-suited for undecided investors who think the index will go only slightly up.

“I like the notes. It’s a more risk-effective way to invest in the developed markets than just being long the fund,” he said.

Credit Suisse Securities (USA) LLC is the underwriter.

The Cusip is 22550WXN2.

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