Credit Suisse’s digital plus notes linked to S&P 500 offer ‘decent’ alternative to equity fund

By Emma Trincal

New York, June 2 – Credit Suisse AG’s 0% digital plus barrier notes due June 28, 2021 linked to the S&P 500 index offer cautiously bullish investors an attractive alternative to a direct investment in the index fund, financial advisers said.

If the index finishes at or above its initial level, the payout at maturity will be par plus the greater of the gain and a fixed payment percentage of 45% to 50% with the exact fixed payment to be set at pricing, according to a 424B2 filing with the Securities and Exchange Commission.

Investors will receive par if the index falls by up to 30% and will be fully exposed to the decline from the initial level if it declines by more than 30%.

Dividends

Tom Balcom, founder of 1650 Wealth Management, analyzed the benefits of the notes, which do not pay dividends, versus a direct equity investment. He concluded that a conservative investor may find the notes more attractive than a fund investment as the structure constitutes a defensive alternative.

“For six years, you obviously don’t earn the dividends; you only get the price return of the index,” he said.

“The question I always ask myself is, who would be the ideal client?

“Obviously, it would be for someone who wants some downside protection. A client without a lot of experience in the market may be more comfortable in terms of the downside risk.”

On the other hand, investors do not earn the “approximately 2% a year” in dividends.

“That’s the only downside. You don’t have the total return of the S&P with 12% in dividends. You have the price return over the next six years,” he said.

“The question for investors is whether the 30% barrier compensates them for that.”

Downside performance

In some cases, investors are better off with the index; in others, they lose less money with the notes, he explained.

“If the index declines by less than 12%, the index would outperform the notes because you would still get some of the dividends instead of just getting par back. If the index is down by more than 30%, you’re also going to outperform with an equity investment because you have the cushion. But if the market is down 12%, you’re flat in line with the index. And if it’s down anywhere between 12% and 30%, you are outperforming the index,” he said.

Rather than looking to beat the index on the downside, the notes target investors seeking equity exposure while securing a “decent” level of downside protection from a pullback in the market, he said.

Liability-based investors

“That type of clients has the liability. The daughter is 12 and going to school in six years. They need to put their money at work for a certain period of time, for example,” he said.

“A bond would yield a very low percentage. But if I have a 45% return, I’d be thrilled.

“I would say this is for a conservative investor who wants equity-like returns, although the term ‘conservative’ is relative. If the market is down 35%, you’re in trouble. But it does provide a deep level of protection.

“Obviously, a bullish investor who doesn’t mind the swings of the market and who would not give up the dividends would not be the right investor for this product.”

Generous

Donald McCoy, financial adviser at Planners Financial Services, said he likes the risk-reward profile of the structure.

“It seems very generous to me. For sure, you’re tying up your money for six years. But most people want exposure to equity anyway, and knowing that if the market is up you’re going to get a minimum of 7% a year, which takes you to 45% to 50% over the six-year term, is quite appealing,” he said.

“You’re sort of removing the market risk and replacing it by credit risk because you’re still relying on the solidity of the issuer. But Credit Suisse I would think has good credit ratings.”

While the market risk is not totally eliminated since the S&P 500 index could theoretically drop by more than 30% in six years, it is significantly reduced, he said.

Fast-coming recovery

“A 30% protection over six years is quite good,” he noted.

“Go back from the 2000-2006 period following the dot-com crash. The market had recovered a great deal if not all of its decline.

“Even with the 2008 historical bear market, it took less than six years for the market to break even.

“I think the 30% barrier seems very attractive because while it’s very possible the S&P would be down six years from now, it’s much less likely that it would be down more than 30%.”

McCoy took today’s value of the S&P 500 index of 2,110. Six years from now, investors would lose money only if the index dropped below 1,477, which represents the threshold for a 30% decline.

“A lot would be going around if that happened,” he said.

In his view, the “worst-case scenarios” do not put noteholders in much worse condition than equity holders.

On the downside, he gave the example of a 60% market drop. In this very negative scenario, the noteholders and equity investors would both suffer significantly.

Another “worst” case would be a strong bull market with the benchmark finishing up 75% from its initial price.

“You’d gain only 65% because of the dividends. Oh no! I’m only making 65% instead of 75%! I think that’s a good problem to have,” he said.

Liquidity

The upside is also “attractive,” he noted.

“If the market is up between zero and 45%, you make money because you get boosted up to the 45% to 50% level.

“If the index is above that, there is no cap.

“If you talk to clients, anyone who expects S&P returns in the upper single digits is stretching it.

“This note is really attractive for clients who need equity exposure. They get it with a downside protection built into it.”

McCoy said the product could have broad appeal.

“It would be suitable for just about anyone,” he said.

“The exception would be the very bullish investors, but those clients are rare today.

“Another case of a person for whom this would not be suitable is someone who needs liquidity because you are tying your money up for six years.”

But almost all investors have pockets of less-liquid investments in their accounts.

“You just carve out a portion of your portfolio for this note. You take a chunk of equity, not all of it.”

Credit Suisse Securities (USA) LLC is the agent.

The notes will price June 19 and settle June 26.

The Cusip number is 22546VEF9.

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