Credit Suisse’s absolute return digital notes on indexes offer high chances of gains with risk

By Emma Trincal

New York, May 19 – Credit Suisse AG, London branch’s 0% absolute return digital barrier securities due June 3, 2022 linked to the S&P 500 index and the Russell 2000 index offer a wide range of positive outcomes but losses can be substantial, said Suzi Hampson, structured products analyst at Future Value Consultants.

If each index finishes at or above the initial level, the payout at maturity will be par plus a fixed return of between 42.5% and 47.5%, with the exact digital return to be set at pricing, according to a 424B2 filed with the Securities and Exchange Commission.

If either index falls but each index finishes above its 60% knock-in level, the payout will be par plus the absolute value of the return of the worse performing index. Otherwise, investors will be fully exposed to any losses.

Wide range

The product offers a high probability of gains in relation to the wide range of positive outcomes.

“In order to get a positive return you only need the worst of the two to finish above 60%,” she said.

Future Value Consultants offer stress-test reports on structured products using market data and simulation models, in order to help investors make decisions. The report is divided in different sections or “tables,” which investors can choose from.

The product specific tests table displays probabilities of various outcomes, which vary depending on the product type. For this absolute return worst-of, the model determines the probabilities of a digital payment, which is 43.97%, as well as the probability of a barrier breach, which is 19.77%. The difference between the two figures represents the chances of making money out of the downside scenario, a 36.26% probability.

“In more than 80% of the time you’re going to get a positive return from this product, which is quite a lot,” she said.

Gains on this five-year note are capped. To run her model, Hampson chose a hypothetical digital payout of 45%, which is about 9% per year. On the downside, investors may earn less than 40%. This maximum absolute return just before the knock-in would provide noteholders with an annual return of 8%.

“You are capped on both sides, which is almost always the case with absolute return. But the band is wide enough to increase your chances of a positive return,” she said.

Big losses

Another table, the scorecard, displays the simulated average performance for each outcome. The positive return outcome includes the fixed return of 45% on the upside. It also captures the one-to-one absolute value of the decline up to but not including 40%. The average gain for those two combined outcomes is 33.3%, according to the scorecard.

On the other hand, the less probable occurrence of a capital loss triggered by a knock-in would hurt investors with an average amount of losses of 39.4%.

“You certainly don’t want to breach the barrier. When it happens, your average loss is close to the barrier. Anything near 60% is very sensitive. It can go either way,” she said.

Different times, markets

A look at the backtested capital performance table showed a brighter picture, which is skewed by the past eight years of bull market, she said.

There was no chance of losing capital in the past five years. For the past 10 and 15 years, probabilities are negligible at 0.12% and 0.08%, respectively.

On simulation mode, the less than 20% chance of breach is relatively low, she said. But it also is the result of the market assumption used to run the forward-looking model. The scorecard is based on a neutral growth scenario. Future Value Consultants however can run similar simulations for four different market scenarios – bullish, bearish, low volatility and high volatility.

While the chances of a barrier breach narrow to 6.22% in a bull market, the risk of occurrence is significantly higher in a bear market with a 41.32% probability, according to the capital performance tests table.

Bear markets are the worst case scenario, she said.

The probability for a knock in in a volatile market is 27%, but it drops to 12% in a less volatile environment, the table showed.

Tradeoff

“Overall this is a product that’s very likely to provide a decent return. The high correlation between the S&P 500 and the Russell is certainly helpful. This product would appeal to investors who need to maximize the chances of getting a fixed return,” she said.

However, the product was not “low-risk” by any mean, she added.

While the chances of losing some of your capital are relatively low, a barrier breach will generate substantial losses.

“Usually people take on risk to chase returns. In this case you’re trying to maximize the chances of making money but at the risk of losing a lot of it if you’re wrong.

“That’s basically the tradeoff.”

Credit Suisse Securities (USA) LLC is the agent.

The notes will price on May 31 and settle on June 5.

The Cusip number is 22550B3B7.

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