Credit Suisse’s $6.6 million callable notes on Russell, Nasdaq pay fixed rate over short tenor

By Emma Trincal

New York, June 16 – Credit Suisse AG, London branch’s $6.6 million of 6.19% trigger callable yield notes due Sept. 14, 2022, linked to the Russell 2000 index and the Nasdaq-100 index pay a competitive rate for a guaranteed coupon over a short maturity, said a market participant.

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

The notes are callable at par of $10 on any monthly coupon payment date after three months.

The payout at maturity will be par unless the lowest performing index finishes below its 60% downside threshold level, in which case investors will be fully exposed to the index’s decline.

Discretionary calls

The call at the issuer’s election is one of the main reasons for the attractive return, the market participant said.

“I have seen certain clients moving from autocalls to issuer calls in order to boost the coupon,” he said.

“Some clients want to have a guaranteed coupon. With volatility down, it’s becoming harder and harder to find attractive yields.”

Issuer calls, which are triggered at the discretion of the issuer, partially help solve this problem.

Another yield enhancement technique used in today’s market consists of including an additional underlying asset in a worst-of, from two to three or even three to four, he noted.

On the other hand, the monthly coupon payment dates and call observations played no role in the pricing, he said.

“Monthly calls may decrease the size of the coupon but only with autocalls. Since this one is an issuer call, it had no impact,” he said.

Low volatility

Autocallable investors are short volatility. The sale of an option garners a premium, which is the value used to price the coupon. Over the past few years, traditional reverse convertibles which used to pay a fixed rate have nearly disappeared. They have been replaced by contingent coupon autocalls, which pay only if underlying is at or above a certain strike at a certain time. Fixed rates are more expensive to price and therefore not as common.

The declining volatility in the market has compressed the size of the coupons across the board, the market participant said.

The VIX index hit a 52-week low on Monday at 15.04.

As a comparison, during last year’s bear market in March, the VIX rose above 85.

Fair pricing

The Credit Suisse deal providing guaranteed payments seem to have priced relatively well compared to recent deals structured on a contingency basis, according to data compiled by Prospect News.

For instance, Citigroup Global Markets Holdings Inc. priced last week $773,000 of five-year autocallable notes linked to the worst performing of the Nasdaq-100 index, the Dow Jones industrial average and the Russell 2000 index. The notes are automatically called on an annualized observation if the worst-performer is flat or positive. The call premium is 5.55% per year. Some features such as the memory and the automatic call (instead of issuer call) add value to the notes. At the same time, some factors may have justified a higher rate. The contingency of the coupon is an example as well as the five-year term as opposed to 15 months. Also, the worst-of payout consists of three indexes, not two.

Another example, this one from last month, is Toronto-Dominion Bank’s $1 million of five year callable interest barrier notes linked to the least performing of the Nasdaq-100 index, the Russell 2000 index and the S&P 500 index. While the barrier at maturity was attractively low at 55%, the coupon was only 6.45% despite the contingency and the long maturity.

Capped upside, barrier risk

Regardless of the pricing of the terms or the guarantee of coupon payments, some advisers are just not inclined to buy income products with call features in general.

One of them said he would not consider Credit Suisse callable notes.

“It’s not a bad deal, but we would not be interested,” he said.

He did point out though to some of the appealing terms.

“We like the short tenor and the credit of the issuer. The 40% barrier is significant as well.

“You will get your 6.19% coupon unless they call you after three months, which they may.

“And so long as the worst-of is above 60% you get your principal back.

“These are all good things,” he said.

But this adviser said the payout of a bond-like product did not match his expectations.

“We don’t like the asymmetrical risk-return of those autocalls in general,” he said.

“Here, for 0.5% a month, you’re taking a fair amount of risk.

“What if 15 months from now, things are horrible with either one of the two indices?”

Volatility was a factor.

“Small-caps are volatile and so is tech,” he said.

Low correlation

Another issue was the low correlation between the two underlying, which is always an important metric when analyzing the probabilities of success in a worst-of product.

The coefficient of correlation between the Russell 2000 index and the Nasdaq-100 index is 0.513.

In comparison, the correlation between the Nasdaq-100 and the S&P 500 index is 0.874. Between the Russell 2000 and the S&P 500 the coefficient is 0.794. A coefficient of 1 is considered to be a perfect correlation.

“You’re betting a lot for 6.2% a year especially if you consider that they may call you in three months,” he said.

“In that regard, I’d be curious to know what would make the issuer decide to call you.”

Since the issuer is obligated to pay the coupon regardless of the market performance, equity returns would not be a factor, he reasoned. The most likely trigger, as disclosed in the prospectus, would be if interest rates in general declined below the coupon rate.

“At least with an autocall, the trigger for the call is known and automatic. This issuer call adds another layer of uncertainty.

“Volatile indices, poor correlation, call risk. I don’t particularly like the notes,” he said.

UBS Financial Services Inc. is the agent.

The notes settled on Monday.

The Cusip number is 22552Y267.

The fee is 0%.

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