Credit Suisse's high/low yield notes linked to Russell, funds offer income, worst-of structure

By Emma Trincal

New York, March 12 - Credit Suisse AG, Nassau Branch's high/low coupon callable yield notes due March 19, 2015 linked to the Russell 2000 index, the United States Oil Fund, LP and the Market Vectors Gold Miners exchange-traded fund are designed for income investors who do not anticipate wide market moves, sources said.

A knock-in event will occur if any underlying component closes at or below its knock-in level, 60% of its initial level, during the life of the notes, according to a 424B2 filing with the Securities and Exchange Commission.

The coupon will be 11% unless a knock-in event occurs, in which case the coupon will be 1% for that and each subsequent payment period. Interest is payable monthly.

The payout at maturity will be par unless a knock-in event has occurred, in which case the payout will be par plus the return of the lowest-performing underlying component, up to a maximum payout of par.

The notes are callable at par on any interest payment date.

Atypical worst of

"This is a little different from the traditional worst-of product," a structurer said.

Credit Suisse issues high/low coupon callable yield notes on a regular basis, according to Prospect News data. But the structure remains atypical compared to most worst-of products, the structurer noted.

"Usually, the barrier option used in a worst of is going to determine how much principal you get at maturity and it's not going to impact the amount of coupon you get, which is usually fixed. This note doesn't have a fixed coupon. It's either 11% a year if there is no knock-in or it's 1%. It's slightly different.

"Most of the worst of I've seen are based around a fixed coupon with an autocall. You get for instance 5% a year, and if the notes are called, they pay you an additional 5%. Or I've seen worst of tied to Libor," he said.

The call feature added a level of complexity, he noted.

"Those callable anytime structures are difficult to judge. They depend on so many factors. Usually, an autocall depends on one factor and that's the level of the underlying.

"But a callable note might depend on a myriad of other things - the underlying but also the volatility, the yield curve and so on and so forth."

Hard to manage

"I don't like callable notes. They usually call it at the worst time for the investor. On the other hand, if it was simply an autocallable, you would have a lower rate; they probably wouldn't offer you 11%," the structurer said.

The notes are linked to three components that reflect different asset classes: the Russell 2000 for the U.S. small-cap equity universe, the United States Oil Fund, which tracks the price of West Texas Intermediate light sweet crude oil, and the gold miners ETF, which reflects the price of gold stocks.

"Unless you're a quant analyst, it might be impossible to manage. The investor would have to be bullish on all three asset classes. It sounds pretty complicated," the structurer said.

"Usually investors have an allocation by asset class, for instance 50% small caps, 20% bonds and 10% oil.

"This issuer makes it very difficult to manage. You have exposure to very different things. You're taking the worst of risk. And it's hard to establish a benchmark against that portfolio."

High coupon

Michael Iver, founder of iVerit Consultancy and a former structurer, said that the notes were not designed for growth or exposure to a particular mix of asset classes but rather for income.

He stressed the relatively high coupon of 11% a year that applies as long as there is no knock-in event.

The high coupon was the result of several factors, he said.

First, the investor is selling away a knock-in put on the worst of three underlyings, he said.

"The knock-in is struck well below where the market is. If it falls to 40% down, the knock-in put is exercised, which is something you don't want to happen. Hence the higher yield to compensate you for that risk," he said.

The existence of three underlying components observed separately introduced another risk element, he said.

"Investors in those worst of want to have the underlyings as highly correlated as possible, so that they behave as closely as possible as one asset with only one chance of getting knocked in," he said.

"We have three underlying components here and not two. So it should increase the risk and justify a higher coupon, However, there is a mitigation factor here because oil and gold, or even gold stocks, tend to be more correlated with one another, so it's almost as if you had two assets instead of three," he said.

Finally, the early redemption provision also helped explain the yield.

"Some of the coupon comes from the call. The issuer will pay you a higher coupon for the right to take that coupon away from you," he said.

Given the call feature, investors should probably not expect to be paid the full 11% coupon payment for the entire two-year life of the notes, he said.

In-between area

"The investor hopes to get paid as much as possible and for as long as possible navigating between two risks: being called if the underlyings go up and being knocked in if they go down," he said.

"The rationale is that they don't expect to be knocked in, otherwise they wouldn't put their principal at risk for the high coupon.

"And while the call is always a possibility, they hope to be able to collect the 11% coupon for as long as possible. Even if it's only for six months, the 11% yield is still much better than a money market instrument."

Investors in the notes are certainly not bullish, he said. But they could be mildly bearish.

"You want to be in the middle ground," he said.

"If I think that the chances of having any of these assets fall by 40% are limited, I might as well enjoy the 11% coupon hoping that the underlyings will not go down to the point where I risk getting knocked in. At the same time, I don't really want the underlying assets to go up too much to the point that I risk getting called away," he said.

"It's almost like selling a straddle. You're selling volatility.

"It's for that in-between area: you go down a little bit, enough not to get knocked in, and you can stay flat or up but not up by a lot so that you're not going to get called.

"You want to avoid the knock-in, which would put your capital at risk and force you to replace the high coupon with a low one. And you also want to avoid getting called as the issuer would then be taking away your coupon. That's the view.

"If you think the Russell is due for a correction but not a collapse, if you believe that you're not going to get knocked in, then you might consider the product. You can get an 11% for a while. You may get called, but there are worse things in life."

Credit Suisse Securities (USA) LLC is the underwriter.

The notes will price Thursday and settle March 19.

The Cusip number is 22546T3X7.

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