Credit Suisse’s $1.72 million notes on indexes offer protection for bearish, conservative play

By Emma Trincal

New York, Aug. 22 – Credit Suisse AG, London Branch’s $1.72 million of 0% CS notes due Aug. 20, 2025 linked to the S&P 500 index, the Dow Jones industrial average and the Nasdaq-100 index offer a nearly full principal protection against market risk over a relatively short tenor, a financial adviser said. But investors need to be comfortable with the worst-of payout and can’t be overly bullish in order to take advantage of the structure.

If each index finishes at or above its initial level, the payout at maturity will be par plus the return of the laggard index, subject to a maximum payout of par plus 53%, according to a 424B2 filing with the Securities and Exchange.

Otherwise, investors will lose 1% for each 1% decline of the worst performer from the initial level to a minimum payout of 95% of par.

Good for bears

For bears, the structure is nearly perfect, a market participant said.

“There is a growing demand for principal protection because people are afraid to jump in the stock market,” he said.

“We had a strong rally since June, but it was a bear rally, that’s what it was. Anytime I see a market rally I ask myself: what changed from yesterday? The economy is still terrible, inflation is still high, the yield curve is inverted. It doesn’t look like the end of a bear market to me.”

“A note with 95% protection is as good as you’re gonna get.”

No cap on the rebound

Lance Roberts, chief investment officer at RIA Advisors, held the opposite view given his own market outlook.

“I wouldn’t consider it,” he said.

“We’re already probably through a bear market. If you’re bearish, this note is OK. But if the bear market is over, you want to be invested in stocks, and now you have a 53% cap.

“If you had shown me this note back in January, I would have said: yes, it makes sense.

“But we’re too far through the bear market. I’d rather be long.”

Even if the bear market may not be quite over, downturn cycles tend to be short-lived.

The average length of a bear market is 18 months, according to data from S&P Dow Jones Indices dating back to 1929.

The current pullback started in November for the Nasdaq and in January for the S&P 500 index.

“Maybe we have another 12 months. Maybe another 20% drop. That’s why I want to be a buyer and not be capped at 53%,” he said.

Worst-of

Carl Kunhardt, wealth adviser at Quest Capital Management, said he liked the defensive structure of the notes. But he was very reluctant to invest in a worst-of.

“It’s very unusual to see principal-protection on a three-year. It’s not 100%, but 95% is close enough,” he said. “That’s why they had to use a worst-of, and they used three indices and not two.

“I have a personal bias against worst-of though. You’re betting against yourself.”

Cap

But the risk-adjusted return was attractive.

“If you buy that note, you buy it for defense purposes. You buy it for the protection,” he said.

Kunhardt was satisfied with the upside payoff including the cap.

“A 53% cap, or roughly 17% a year, is really not going to limit my upside. In fact, to me the cap is moot.”

Kunhardt explained that his return expectations on the S&P 500 index – between 7% and 8% a year – are sharply below the cap level.

“Some may say that having no leverage is a problem. To me it’s irrelevant.

“And if 17% a year is not enough for you, you’re not an investor...you’re a speculator. You might as well go to Vegas,” he said.

Dow

In a bull market, the Nasdaq would probably be the best performer and the S&P 500 index, the worst of, he said.

In a declining market, the worst-of would be the Nasdaq and the S&P 500 the best performer, he added.

“The Dow would be the one that sits in the middle. The Dow would be irrelevant and that’s a good thing because I never really found this benchmark to be very useful. It’s 30 stocks picked by the editors of a newspaper. Thirty stocks to me doesn’t represent anything,” he said.

Phantom income

The principal-protection note can pose challenges for the taxpayer. While they don’t earn any income during the life of the security, noteholders will be required to recognize interest income, on which they will be subject to ordinary income taxes each year.

“Nobody likes to pay taxes on something they haven’t earned,” he said.

Allocation, tenor

From an asset allocation standpoint, the note may also raise some issues.

“Where do you fit it? It’s a conservative note. You use it for the protection. But the worst-of is not conservative to me. So, you have to resolve that issue first,” he said.

Finally, while three years is a short duration for a principal-protected note, the tenor is above the timeframe Kunhardt is comfortable with when buying structured notes.

“One three-year for us is the long-end. We like to keep notes between 18 months and two years. After that, you’re locked in. Three years is really our maximum,” he said.

“When the environment is uncertain, it’s a way to motivate someone to participate in the market. I like the downside protection a lot. But I may be hesitant to use it for a client because of the worst-of.”

Credit Suisse Securities (USA) LLC is the agent.

The notes settled on Thursday.

The Cusip number is 22553QGG6.

The fee is 0.75%.

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