Credit Suisse's absolute return barrier notes linked to indexes offer hedge if market declines

By Emma Trincal

New York, Dec. 5 - Credit Suisse AG's 0% absolute return barrier securities due Dec. 29, 2017 linked to the S&P 500 index and the Russell 2000 index offer a chance for investors to hedge a possible correction within the next four years, sources said, adding that the structure is more attractive on the downside.

The notes enable investors to profit from a market decline up to a point, according to a 424B2 filing with the Securities and Exchange Commission.

If the final level of the lower-performing index is greater than or equal to its initial level, the payout at maturity will be par plus the return of the lower-performing index, subject to a maximum return of 29.9% to 33.9% that will be set at pricing.

If the final level of the lower-performing index is less than its initial level but above a 66% to 70% knock-in level, the payout will be par plus the absolute value of the lower-performing index's return.

If the final level of the lower-performing index is less than the knock-in level, investors will be fully exposed to the decline of the lower-performing index.

Attractive barrier

"It's very interesting structure," said Matt Medeiros, president and chief executive officer of the Institute for Wealth Management.

"I like the idea of the inverse return on the negative index, even if it's the worst of the two."

While the risk of the worst-performing index dropping by more than 30% is real, Medeiros said that "I see it as a limited risk for both indexes and four years from now."

If both underlying indexes decline within the range (above the assumed 70% knock-in-level), investors would actually be better off being exposed to the worst-performing index because their absolute return would be greater, he said.

"Having those two asset classes to monitor is also attractive because I'm still reasonably optimistic about the potential of the S&P 500 and the Russell for the next four years," he said.

"It's a good structure if you want to gain equity exposure and still have an attractive buffer on the downside."

However, investors in the notes should not be very bullish, he noted, pointing to the upside cap.

"I always prefer to have no cap. I wouldn't be concerned about having no leverage, but the 30% cap on the upside over four years is not that attractive. The S&P has been up 30% this year. Historically, it's 8%, close to 10%. With that 30% cap, you're going to take a haircut," he said.

"This note I guess would work best for someone who is neutral, someone who anticipates that the market will trade range bound. But it's not aimed at bulls."

Market cycles

Steve Doucette, financial adviser at Proctor Financial, said that based on market cycles, the four-year tenor is too long to enable investors to maximize the chances of benefiting from the absolute return feature.

"It's a four-year [note]. We may have a market adjustment since we've been in a bull market for more than four years. But the question is when. If we're in a bear market when the notes mature, the absolute return component may work for you. But again, we may not be in a bear market by then," he said.

"Problem is the notes won't be valued at 100% to the index. The more I get close to maturity if we're in a bear market, the more value the option [has] and I'm ahead of the indices. But clients may not necessarily like the protection component if the market is back up.

"We get a bear market every four-and-a-half years on average. And the average length of a bear market is six months to one year. Since we've been in a bull market since March 2009, I would expect that note to carry us a little further beyond a bear market. You would be stuck without enjoying the value of the option as it would become worthless in an up market. This four-year term complicates the valuation of the notes. It may not end up being valued close to the index if the market recovers from a correction just at the end of the term.

"Bottom line, you want this note with a two-year duration based on normal market cycles.

"If you hold it for one or two years, the market, say, is down 20% and you could be up 20%. It's more likely that we'll go through a bear market within two years than four years from now, just based on the length of normal market cycles."

Credit Suisse Securities (USA) LLC is the underwriter.

The notes are expected to price Dec. 27 and settle Dec. 31.

The Cusip number is 22547QEE2.

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