Credit Suisse's autocallable notes tied to S&P, Russell show reasonable risk for a worst of

By Emma Trincal

New York, Feb. 14 - Credit Suisse AG's 0% equity-linked autocallable step-up notes due Feb. 28, 2017 tied to the performance of the S&P 500 index and the Russell 2000 index show a relatively moderate level of risk considering that the securities are linked to the performance of two separate underlying indexes, said Suzi Hampson, structured products analyst at Future Value Consultants.

If both indexes close at or above their respective trigger levels on an annual review date, the notes will be automatically redeemed at par plus a premium of 8.25% to 8.75% per year, according to a 424B2 filing with the Securities and Exchange Commission.

The trigger level is expected to be about 100% of the initial level. The exact call premium and trigger level will be set at pricing.

If the notes are not called, the payout at maturity will be par plus the underlying return of the lower performing index.

If the final level of either index is less than its knock-in level, expected to be 70% of the initial level, the underlying return will equal the index return. Otherwise, the underlying return will equal zero.

Two underlying indexes

The notes fit under Future Value Consultants' "review" category, which she defined as income product paying a contingent coupon.

"Review notes are pretty common. You get the annualized payment with the call," she said.

"What makes this one different is the existence of the two components instead of just one.

"The introduction of two underlying brings more uncertainty and risk.

"In this case, the contingency is that you need both underlying to close at a particular level in order to get called. In this case it's 100% of the initial price."

The notes are also not linked to the performance of a basket, in which the decline of one component would be mitigated by the gains in another, according to the prospectus.

Being able to distinguish the implications of having a payout tied to two separate indexes requires investors to be educated on the effect of correlation, she said.

"As far as the investors' level of understanding goes, those so-called 'worst of' products are more complex," she said.

"It's more difficult for an adviser to explain the different call conditions and to make investors understand the implications of the assets' correlation.

"To begin with, it's hard for an investor to have a view on correlation. You may have a view on what the S&P 500 or the Russell will be in three years, that's one thing. That's another one to have a view on how they will behave together."

Correlation

The risk associated with a note tied to two separate indexes is reduced when their correlation is high, she said.

"The higher the correlation between the two, the closer the underlying assets become similar to a single underlying asset. If they were perfectly correlated, the product would be similar to a note linked to a single underlying. You want those underlying assets to be correlated. They need to move together in order for you to get called. If one moves one way and the other moves the other way, it greatly reduces your chances of getting called," she said.

While the worst of payout introduces more uncertainty, the correlation contributed to mitigate the risk, she explained.

The first one was the 89% correlation between the S&P 500 and the Russell 2000.

"That's high," she said.

"By using two assets, the issuer is introducing more risk. As a result, they can offer a higher return.

"But they have chosen two underlying that are highly correlated. Therefore the risk is not as high as if they had picked uncorrelated assets."

Credit risk

The riskmap is Future Value Consultants' measure on a scale of zero to 10 of the risk associated with a product with 10 being the highest level of risk possible.

It is the sum of two risk components: market risk and credit risk.

The credit riskmap of the product (0.39) is about the same as the average review note (0.38).

"When we assess credit risk for an autocall, we take into account the expected duration of the product because the actual duration when the notes are called is less than the actual maturity," she said.

"So although this is a three-year, we expect this product to finish early. It reduces the duration and therefore, the credit risk. This is why we have an average credit risk."

Market risk

On the other hand, the market riskmap is less than average for this product.

Its 3.04 market riskmap is lower than 3.20, the average for the same product type, according to Future Value Consultants' research report.

"We know that having two underliers introduces more risk. And yet the market riskmap is lower. One reason is relative. You need to look at what we're comparing this product to. The review category is a pretty wide universe in itself. It includes notes tied to a single underlying or notes tied to a basket. You could have no downside protection at all or you could have a10% buffer or a barrier. The barrier could be final or observed daily. And you could look at stocks, indexes or funds as underlyings. There is quite a lot of diversity in risk profiles.

"In this case we have the worst of risk. But that risk factor is tempered by the fact that the two indexes are highly correlated. They are indexes, not single-stocks. You have a seemingly good barrier at 70%. It's a final barrier. All those factors contribute greatly to lower the market riskmap," she said.

As a result, the product has a 3.43 riskmap compared to 3.58 for the average of its peers.

"It's slightly surprising to see the risk as average or even slightly lower. With two underlying you would expect more. But again, the correlation factor and the barrier factor contribute to remove a lot of the additional risk," she said.

Income investors

Investors likely to be interested in the notes would have to be primarily focused on income, she said.

"However, the payment is not guaranteed. So although it's similar to an income product, it's not going to guarantee you any income," she added.

"It's aimed at people willing to cap growth, people looking for a target return. You only need a small amount of growth from the underlying assets. It works best in a low-growth, low-volatile environment."

Also investors would have to be flexible about the maturity.

"An investor who needs money in one-year time is not going to invest because you have no way to know if you're going to get called or not. Alternatively, you need to be flexible if there is early redemption as you have to be prepared to reinvest your proceeds," she said.

Return score

Future Value measures the risk-adjusted return with its return score. The rating is calculated using five key market assumptions - neutral assumption, bull and bear markets, and high and low volatility environments. A risk-adjusted average return for each assumption set is then calculated. The return score is based on the best of the five scenarios.

The best scenario with this product is low volatility, she said.

The product has a 6.95 return score versus 6.65 for the average of its peers.

"The return score is higher than average. It gives you an indication of the return you get for a given level of risk.

"You have a slightly lower riskmap than average and a slightly higher return score.

"So far both the riskmap and the return score are positive.

"But the good picture somehow disappears with the price score. The price score is not so good, "she said.

Weak price score

For each product, Future Value computes a price score that measures the value to the investor on a scale of zero to 10.

This rating estimates the fees taken per annum. The higher the score, the lower the fees and the greater the value offered to the investor.

The price score for the notes is 6.67. The average price score for that category in comparison is 7.61.

"The score gives you an indication of the value for your money," she said.

This price score shows that the issuer has not spent as much on the options as it should have compared to the average for this product type.

"It's hard to pinpoint where they should have spent more. The kickout autocallable option is complex. You have the barrier level, the call trigger; all these different terms are intertwined. But what we do we know is that they probably should have spent more on the options.

Another possible factor was the hypothetical value chosen for the call premium, which the issuer announced in a range between 8.25% and 8.75%.

Future Value Consultants picked the value 25% below the higher-end of the range, at 8.625%, according to its convention when terms are not fixed.

"If they were to price it at 8.75% instead, the price score would of course improve. So this is one of those deals where you don't know for sure until pricing," she said.

Overall score

The overall score measures Future Value Consultants' general opinion on the quality of a deal. The score is simply the average of the price score and the return score.

The overall score is 6.81 for the notes compared to 7.13 for the average in this category.

"It's below average," she said.

"We had a decent riskmap and good return score. Up until that point the scores were very good.

"If we had a change in the price score, it would impact the overall score as well.

"The issuer introduced a second underlying to give investors a higher headline rate. In addition, the risk is reduced by the correlation and the type of barrier employed. So even though the price score is disappointing, it's not bad. "Some investors may still be interested in that from a risk-reward standpoint," she said.

Credit Suisse Securities (USA) LLC is the agent.

The notes will price on Feb. 21 and settle on Feb. 28.

The Cusip number is 22547QHA7.

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