Credit Suisse’s 8.2% autocalls on S&P, Russell show moderate risk despite American barrier

By Emma Trincal

New York, June 21 – Credit Suisse AG, London Branch’s 8.2% autocallable yield notes due Oct. 5, 2020 linked to the S&P 500 index and Russell 2000 index offer a fixed interest rate on a short tenor, which could be done with the use of a riskier barrier and a worst-of payout.

Overall though, the risk is not as high as one may expect, said Tim Mortimer, managing director of Future Value Consultants.

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

The notes will be called at par if each index closes at or above its initial level on any of three trigger observation dates: Dec. 30, 2019, March 31, 2020 and June 30, 2020.

The payout at maturity will be par unless any underlying index ever closes below its 75% knock-in level on any day during the life of the notes, in which case investors will be fully exposed to any losses of the worst performing index.

Outlook

“It’s a relatively short-dated note. It’s the worst of the S&P and the Russell 2000, which are both U.S. indices...large-cap and smaller-cap but both recognizable by U.S. investors and highly correlated,” said Mortimer.

“You’ll get 8.2% per annum for the time you’ll stay invested knowing that you can be called after six months.

“The S&P is pushing new highs which makes some people nervous. But buying this product will really depend on your market outlook,” he said.

“All you need is the index not to go down by 25% during that short period of time. 25% is quite a big drop. And 8% is a strong return.”

American, short tenor

What makes the structure different is the short maturity associated with a guaranteed coupon. In order to price the notes, the issuer had to set an “American barrier,” a term that refers to the daily or periodical observations of the barrier as opposed to the point-to-point seen with the more commonly used European barrier.

Despite the use of a riskier observation, the risk was relatively contained, he said.

“Most longer-dated products have European barriers, but because the tenor here is relatively short, an American barrier is fine,” he noted.

“The 8.2% coupon offers a significant spread over what you would expect from a Credit Suisse bond. As a result, investors have to expect significant capital risk.”

Investor scorecard

Future Value Consultants specializes in generating stress testing reports on structured notes. Each report consists of 29 tables or tests.

Mortimer began his analysis using one of the most commonly used tables – the investor scorecard. It consists of the different mutually exclusive outcomes of product performance so that the sum of the probabilities will add up to 100%.

The table displayed the probabilities of calls at point 1 (first call date on the sixth month), point 2 and point 3.

Investors have a 50.71% chance of being called on the first call date, according to the scorecard.

“These are typical probabilities,” he said.

“One chance out of two for a call on the first call point is pretty standard.

“Then the probabilities decrease as you go along.”

A call on the second observation date will happen 10.14% of the time. The probability drops to 5.73% at point 3.

Adding the three call probabilities gives an overall chance of an automatic call of 66.58%. This two-third probability may not be the most attractive feature of the notes.

“Because it pays a fixed return you don’t mind not being called actually. In fact, it’s better not to be called so you can carry on as long as possible. Your maximum return over the 15-month period is 10.25%,” he said.

Average payoffs

The other scenarios are loss of capital, which happens 17.2% of the time. A separate outcome with a small probability of 1.93% associated to it represents the cases in which investors should incur capital loss but end up in the black thanks to the fixed payment.

“Because your coupon is guaranteed, if you lose some capital, the coupon will compensate for it. But it doesn’t happen very often,” he said.

The average payoff in that case is 104.4%, according to the table, which lists this information in a separate column. Finally, the “full capital return” showed a 14.29% probability. In this scenario, investors get 100% of their principal back with the full coupon payment. The 10.25% average payoff is therefore the full income stream over the term, or 110.25%.

The worst scenario, named “total return loss,” is the one in which investors lose money at the end despite the fixed income. The average payoff is in this case a 78.2% payoff, a 21.8% loss of principal.

“The coupon is a risk-reducing element. It will help offset the losses,” he said.

Strong back testing

The report also provides a back-tested equivalent of the simulated scorecard displayed in a separate table. It showed the frequency of occurrence over the last five, 10 and 15 years for all the previous outcomes.

“We just touched an all-time high on Thursday. The bull market has been robust in the last few years. As a result, the back-tested tables look very strong, especially for the last five years,” he said.

Investors over the past five years have not incurred any losses, according to the back-testing analysis. In the past 10 years, losses were recorded 5.36% of the time. In the last 15 years, the frequency rose to 8.39%.

“If you look at the average payoff, you would get 77.5% of your principal back over the last 15 years if you lost money while it would be 87.4% in the last 10 years, which is better.

“By taking the 15-year period, not only have you got the worst outcome but the average loss is higher.

“No doubt those results are due to the financial crisis, which is captured in the 15-year stretch.”

But while the 15-year period was not the best among the three timeframes, it was still positive in many ways.

For instance, the frequency of a call at point 1 was 68.18% in that timeframe, which is much more than the 51% probability seen in the simulation.

“Even over the 15-year back-tested period, it’s still a pretty strong result. 68% of the time you come out on the first call, which is after just six months. It means the odds of losing money are small,” he said referring to the 8.39% probability associated with this outcome.

Low riskmap

Overall, Mortimer said the risk associated with the notes was not excessive.

He pointed to one of the simulation scores, the riskmap, which rates risk on a scale of 1 to 10, with 10 being the highest risk. Risk is measured based on how the product would underperform the risk-free rate plus the issuer funding level.

The riskmap for this product is 2.30, according to the report.

“I would say it is a pretty low-risk product,” he said.

“Although the barrier is American, the duration is so short, it would take a while to get to a 25% drop so it’s not such a big deal.”

“It’s also not such a big deal because you get a fixed coupon.

Cushion

“Unlike a Phoenix autocall in which your payment is conditional, or a snowball autocall, which will pay you only when you come out, here you know you’ll have a 10% income as a cushion. Whatever loss you have, the 10% is going to compensate some or all of it.

“Even if the barrier is going to be breached it’s not such a great loss, which is what is reflected in the low riskmap.

“It’s all about your view on the U.S. market and how you assess the chances of a significant fall.”

Credit Suisse Securities (USA) LLC is the agent.

The notes will price on June 28.

The Cusip number is 22552FKB7.

© 2015 Prospect News.
All content on this website is protected by copyright law in the U.S. and elsewhere. For the use of the person downloading only.
Redistribution and copying are prohibited by law without written permission in advance from Prospect News.
Redistribution or copying includes e-mailing, printing multiple copies or any other form of reproduction.