Credit Suisse's three-year Bares linked to Russell 2000 index target mildly bullish investors

By Emma Trincal

New York, July 26 - Credit Suisse AG, Nassau Branch's 0% Buffered Accelerated Return Equity Securities due Aug. 2, 2016 linked to the Russell 2000 index are designed for moderately bullish investors, but the maximum return offered compared to the risk exposure makes the notes less attractive than other comparable products on a risk-adjusted return scale, said Suzi Hampson, structured products analyst at Future Value Consultants.

The notes fall into the digital product category. As such, they are rated against similar products belonging to the "same product type" category, which Future Value Consultants uses in its methodology.

Separately, the product is also compared to the "average of all products," which represent all recently rated notes in all structure types, including leveraged notes, reverse convertibles, autocallables and all other structures.

If the index finishes at or above the initial level, the payout at maturity will be par plus the fixed payment, which is expected to be 19% to 21% and will be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 20% and will be exposed to any losses beyond 20%.

"This is a target product. Rather than participating in the growth of the underlying, you're getting a fixed payment if the index meets certain conditions," Hampson said.

"This product represents an alternative to investing in a tracker fund or in the index directly. It's just a lower-risk version, and there is no variation in the return. You're capping your return in exchange for outperforming between par and the digital level. This is a different type of return than pure equity, but it doesn't mean there is no risk in the structure. You still need to understand the underlying and the various risks involved."

Market risk

The riskmap is a rating created by Future Value Consultants. It measures on a scale of zero to 10 the risk associated with a product. Ten is the highest level of risk possible. The riskmap is the sum of two risk components: market risk and credit risk.

The riskmap for the notes is 3.27. The digital category has a 3.60 average riskmap. In comparison, the average riskmap for all products is 3.94.

Hampson looked at the 2.60 market riskmap for the product. Similar notes show an average market risk of 2.89.

"This riskmap offers a good indicator of the level of protection," she said.

"The market riskmap is lower than the average of the same product type. This could reflect differences in maturity or the fact that we have a buffer rather than a barrier. Usually, some buffers are at about 10%, but this is a slightly longer maturity than normal, so it's logical that you would get a bigger buffer. In fact, this large size buffer doesn't necessarily equate to a significant reduction of risk.

"You need to look at a combination of factors and their impact on the risk rather than at the buffer itself. A headline rate or headline terms alone don't offer enough conclusive information to draw conclusions.

"What we can say is that this product shows a slightly lower market riskmap than its peers but that the difference isn't much. It could be due to the buffer factor versus the barrier or perhaps the underlying, which is less risky than some of the underlying used in other digital products. However, despite the big buffer, the risk is not substantially lower than what you find with comparable notes."

The difference in market riskmaps was more significant between the notes and the overall market, she noted. The average market riskmap for all products is 3.46.

"We're seeing less risk. This has to do with the fact that a lot of the products in the general category belong to the riskier, shorter-dated reverse convertible category of notes," she said.

Moderately bullish

Investors in the notes are not seeking growth, she noted. In fact, they are willing to give up any upside participation above the digital payout.

"In a way, it's somewhat similar to an autocallable. As long as some conditions are met, you get your fixed payout. If the underlying is negative but above the buffer level, you get par; otherwise, you lose some principal," she said.

"Compared to a growth product with participation in the upside, you're still exposed to the risk of the underlying, but your risk return profile has changed dramatically.

"Rather than being bullish on the index, investors considering these notes may anticipate small to moderate gains over the period. That's when you can outperform the underlying index."

Expectations of index growth should be rather subdued, she said, pointing to the 19% to 21% digital payout.

"Over three years, it doesn't sound like a headline-grabbing payout. This is really for the mildly bullish investor. Anyone expecting a lot of movement in the index should not consider the notes."

At 0.67, the credit riskmap is similar to the 0.70 score for similar products on the same scale. However, the notes present more credit risk than the average product, which shows a 0.48 credit riskmap.

Hampson said the difference was due to the longer maturity rather than to the creditworthiness of the issuer.

Five-year credit default swap spreads are 99 basis points for Credit Suisse, she said.

"It's pretty much average when compared to other banks. Bank of America has a 107 basis points spread, and JP Morgan is at 84. Then there is Morgan Stanley at 140, but overall, they're average," she said.

"The reason these notes show much higher credit risk than all products is duration. This three-year term contrasts with the abundance of three-month or six-month reverse convertibles you find in the all-product-type category."

Weak return score

Future Value Consultants measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions: neutral assumption, bull and bear markets and high- and low-volatility environments. A risk-adjusted average return for each assumption set is then calculated. The return score is based on the best of the five scenarios.

At 6.77, the return score is markedly lower than the average of the same product type of 7.37, she said.

The calculation is based on the optimal market assumption, which for this product is bullish.

"The volatility of the underlying is relatively low. We wouldn't be expecting the type of return you would get from a three-month reverse convertible tied to a stock. We have a different product structure on a different underlying. That said, this digital range doesn't seem particularly high, which contributes to a lower return score that's below average for this particular note. Some other products are offering better levels of return," she said.

"It's not so much that the risk is high. It's more like the potential gains are muted.

"The lower return score suggests that other products offer higher returns for similar levels of risk. Or you could have other digitals that are riskier but that offer higher returns."

The return score is slightly above the average of all products, which is 6.69, she noted.

"That difference is very slim, however," she said.

"What's more striking in terms of return score is the difference between this product and those in the same structure type. That difference suggests that other digital notes offer a better risk return."

With its probability chart, Future Value Consultants estimates how the product is expected to perform under the five key assumptions. It assigns a probability of return outcome to each of the payoff buckets. The chart is generated using a Monte Carlo simulation using various parameters such as volatility, dividends and interest rates.

When selecting the bullish assumption used in the report, the notes show a 67.4% probability of earning between 5% and 10% per annum. A 0% to 5% return per year corresponds to a 13.6% probability. On the other hand, investors have a 19% chance of losing principal. Within that 19% probability, the odds of losing more than 15% per year are 7.6%, according to the report.

Price, overall scores

For each product, Future Value Consultants computes a price score that measures the value to the investor on a scale of zero to 10. This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

The notes have a 6.28 price score, compared with 7.08 for similar product type and 6.78 for all products.

"The price score is below par. It's below average compared to the same product type but also in relation to all products," she said.

"This is based off the future value of the product given the duration."

The lower score suggests that, compared to similar products, the notes are not offering as much value for the dollars spent. In general, this tends to indicate that the issuer has been taking out higher levels of fees.

"Sometimes with shorter-maturity products, we can explain why a price score is lower in relation to the fact that the fees are annualized. But with a three-year, this product's price score should not be penalized at all," she said.

"Also, this is a pretty straightforward structure built on a very well-known benchmark. There's no complexity. Differences between price scores from a firm to another increase with the complexity of a product, whereas with liquid, common underlying - we're talking about digital options and a put - the price tends to be more stable. We notice fewer differences between issuers, and therefore there is less room for gaps. Different banks can have different price scores. But clearly, complexity is not a factor here.

"Is this relatively poor price score the result of our assumptions since the digital payout is expressed in a range? We'll see what happens on Monday. If they choose the higher end of that range, we should expect the score to go up. It could make a difference, although I doubt that it would be much since the two-point range is pretty narrow."

Future Value Consultants offers its opinion on the quality of a deal with its overall score. The score is simply the average of the price score and the return score.

The notes have a 6.52 overall score. The average overall score is 6.74 and 7.24 for all products and the same product type, respectively.

"The overall is below average. Both the return score and the price score are lower, so the resulting score, which is the big picture, is disappointing and it comes as no surprise," she said.

"By simply reading the return score, one can conclude that investors might be able to get a better risk return from a different product."

Credit Suisse Securities (USA) LLC is the underwriter.

The notes will price Monday and settle Wednesday.

The Cusip number is 22547Q4V5.

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