Credit risk takes precedence with Credit Suisse’s buffered leveraged notes on S&P, advisers say

By Emma Trincal

New York, Nov. 1 – Credit Suisse AG, London Branch’s 0% buffered accelerated return equity securities due Nov. 4, 2024 linked to the S&P 500 index raised the issue of credit risk as the Swiss bank is going through a painful recapitalization and restructuring process after incurring heavy losses last year. While advisers said the terms of the structure were reasonable, they were reluctant to be exposed to the credit risk of this issuer as measured by record high credit spreads.

If the index return is flat or positive, the payout at maturity will be par plus 300% of the index return, up to a maximum return expected to be between 36% and 40%, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by 10% or less and will lose 1% for every 1% decline beyond 10%.

The exact participation rate, maximum return and buffer amount were to be set at pricing.

Pullback

“I like it. The 3x with the cap gives you a nice return. Assuming the cap is 38% you get more than 17% compounded per year. If a client is unhappy with that, I don’t know what we can do,” said Tom Balcom, founder of 1650 Wealth Management.

Balcom noted that the notes will mature the day before the 2024 Presidential Elections.

“So close to the Elections... volatility will be high around that time,” he said.

But the adviser said he was not overly worried with the equity risk.

“The S&P is down 19% for the year. That’s a comfortable cushion there. Given the current level and the 10% buffer, I think the market risk is limited for that timeframe.

“I always prefer a bigger buffer when we’re at all-time highs. But now that we had this pullback, I’m comfortable with the 10% buffer,” he said.

CDS spreads

Balcom’s main concern was the creditworthiness of the Swiss bank.

“While Credit Suisse is unlikely to go under within the next two years, there is still a risk,” he said.

Credit Suisse Group AG lost billions of dollars last year as a result of the collapse of hedge fund Archegos Capital Management, to which Credit Suisse provided financing.

The share price of the bank is 72% off its February 2021 high prior to the losses. The bank is in the process of raising capital, fending off rumors that it may be in talks to be acquired by another financial institution. In reporting its third-quarter results last week, Credit Suisse announced that it will focus on wealth management and reduce the size of its investment banking business, which incurred losses.

Spreads on the bank’s credit default swaps are now among the widest in Europe, which means that it has become very expensive to secure insurance against default risk.

On Tuesday, the five-year CDS spread rates were at 256 basis points, according to S&P Global Market Intelligence, the widest among the big European banks at the exception of embattled Italian bank Monte dei Paschi.

In comparison, spreads for some of the largest U.S. banks are 93 bps for JPMorgan, 100 for Bank of America and 116 bps for Citigroup and Morgan Stanley.

Reputational risk

“We looked at the spreads of Credit Suisse and these are the types of spreads that generate a lot of clients’ phone calls. We only had one note from this issuer, and we don’t intend to buy more. We tend to stay away from high CDS spreads,” said Balcom.

“I like the terms of the notes. But I don’t think I would want to take the credit risk even if the risk of insolvency is remote.

“No matter how good the terms are, do they really compensate you for that risk?

“If anything happens with the issuer, the client will ask: why did you put my money in this? Too much reputational risk in here. It’s not worth it.”

But Balcom said he does not rule out using this issuer later on.

“We still keep a close watch on it and see how things are improving. If the recapitalization is successful and the bank becomes healthy again, we would consider it in the future,” he said.

Mildly bullish

Donald McCoy, financial adviser at Planners Financial Services, said the terms would be appropriate for moderately bullish investors.

“They’re throwing in a lot of sweeteners, which a lot of banks may not have to,” he said.

“The one thing you have to consider is: do you expect the S&P to be over 38% in two years?

“We had a good run-up in October but we’re still off for the year. Even if there’s a recession next year, you could see the S&P recovering. So, if you’re modestly bullish, the terms on the upside may work for you.”

Headwinds

However, clients should never take for granted an issuer’s ability to make payments at maturity, he said, especially when the market shows signs of nervousness as evidenced by the substantial increase in Credit Suisse’s credit spreads.

“You still have to consider the uncertainty associated with using Credit Suisse. If the markets do well, it’s unlikely that the bank would implode in two years. But if you’re negative about the market, that 10% buffer is not going to be enough to entice you to use this issuer. A recession or a prolonged market sell-off could be challenging for them.

“I think overall the concern is less about the buffer than Credit Suisse itself,” he said.

Even if a credit event or default may not be likely, its impact would be devastating for investors.

“I wouldn’t say insolvency is a significant risk, but if you have the choice between different issuers, you might want to pick other banks.

“You might not get the 3x, but you will feel more comfortable with a different name.

“Credit Suisse is still under a lot of stress,” he said.

Credit Suisse Securities (USA) LLC is the agent.

The notes were expected to price on Oct. 31 and to settle on Nov. 3.

The Cusip number is 22553QNL7.

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