Credit Suisse’s trigger autocallables linked to Russell, Euro Stoxx offer yield, not income

By Emma Trincal

New York, July 5 – Credit Suisse AG, London Branch’s $9.19 million of 0% step-down trigger autocallable notes due June 28, 2019 linked to the Russell 2000 index and the Euro Stoxx 50 index are designed for investors seeking yield but not income as they get paid upon the redemption of the notes, sources said.

While the yield may be attractive, the structure is complex and the risk significant, they noted.

As such, the product would only be a good match for sophisticated investors who don’t need repeated and periodical income payments.

The notes will be called at par plus a call return of 7.77% per year if each index closes at or above its initial level on the first or second annual observation date or at or above its 60% downside threshold on the final valuation date, according to a 424B2 filing with the Securities and Exchange Commission.

If the notes are not called, the investors at maturity will have full exposure to the decline of the worse-performing index.

Tom Balcom, founder of 1650 Wealth Management, said he would only recommend the product to investors who understand the terms and are comfortable with the risk.

“It’s not a simple structure. It’s probably very difficult to explain to a client,” he said.

“I’m not saying it’s a bad note, but it’s more complex than what our clients are used to doing.”

No risk, no yield

The notes may deliver an attractive yield, he noted. Investors could get 7.77% if called on the first year or 15.54% if the notes are redeemed on the second annual call date. If there is no call and the barrier is not breached at maturity, noteholders will collect the full 23.31% payout.

But with yield comes risk.

“In this very low-yield environment there isn’t much you can get out there,” he said.

He pointed to the 10-year Treasury yielding 1.36%.

“People look for yield and they know they have to take on some risk to get it. With structured notes, you have to take on credit risk and market risk. This one also has a worst-of feature. That adds risk too.

“I think people understand that, and if the terms are clear to them, if they’re willing to take on the risk, if they don’t mind the complex terms, this note can certainly provide them with a much better yield than many other securities.”

However, he would not recommend the notes as a fixed-income replacement.

First, the risk is too great.

He said that even if the odds of losing money at the end are very slim – one of the indexes would have to drop by more than 40% three years from now – investors still have full downside exposure if the barrier is breached by one of the benchmarks.

No safety zone

“I’m not saying you can get much better elsewhere. I’m saying that getting yield today means taking risk,” he said.

A high-yield bond for instance would also be risky, “perhaps even riskier” in his view due to the lack of protection.

Receiving dividends from stocks provides good income, but investors are exposed to equity risk, he added.

Fixed-income investors who need safety and predictability of income are not likely to get paid much, he said.

“There’s nothing safe for yield in this market. As long as the investor understands this complex product and is willing to be exposed to this type of risk, it’s definitely a way to get a pretty good yield,” he said.

Premium

But the main factor making these notes ineligible for a fixed-income portfolio is simply the way investors get paid.

“You don’t receive income. You just get a yield when the notes are called or if you reach maturity without hitting the barrier. This is not an income product,” he said.

People who need income prefer regular income throughout the life of the notes, he said.

“With this one, if you get paid, it means you get called.”

As a result, investors who rely on regular income would probably not be interested in the product, he said.

Big swing

Donald McCoy, financial adviser at Planners Financial Services, said he was not comfortable with what he called “the rules” of the structure.

“This is one of those things ... It’s almost like a game. Here are the rules ... If they both close above their initial price on year one, you get called and you get paid, same thing on year two, and if you haven’t been called, you get 23% at the end, otherwise you get the performance of the worse of the two,” McCoy said.

“Here’s the concern. If you’re not called in the first or second year, that means now you’re in some kind of all win or big loss situation. You either make 23% or you lose more than 40%. Between making 23% and losing 40%, that’s a big swing!”

“So you’re getting close to 8% annualized return over three years or you’re losing big.”

Worst of

He did not find the complexity of the notes helpful.

“I can’t imagine explaining it to a client. ... They have to really understand the implications of going into the third year,” he said.

“People would buy that hoping to get called in one of the first two years. That would make sense. You wouldn’t want to be invested during that third year. The risk would be super high.

“Maybe the risk of one index breaching that barrier is mathematically pretty small. But it only takes one to make you lose a lot of money, and having to explain the concept of worst of the two is another thing.

“Go explain to a client that if the Russell is down 38% but the Euro Stoxx is down 43% you’re going to lose 43% of your capital. I don’t think they would be too happy.”

Autocallable

Autocallables notes are not reverse convertibles, which pay a fixed or contingent coupon, he noted.

In that regard, McCoy agreed with Balcom: the notes would not be an attractive fixed-income substitute.

“If you want income, this is not very good. You’re not getting any income until it’s all over, and then you’re getting it all at once,” he said.

McCoy said the structure is too “problematic.” As a result, he would not consider the notes.

“It works too much like a game. It’s definitely not an income product. There is not enough certainty. You don’t know if or when you’re going to get paid, how long you will be holding the notes and whether you’ll get your money back at maturity.

“If you’re a conservative investor looking for income, I don’t think it would work.

“It’s one of those deals that are slightly too clever.”

The notes (Cusip: 22548R608) priced on June 28.

UBS Financial Services Inc. was the distributor.

The fee was 2.5%.

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