Credit Suisse’s digital buffered notes linked to S&P 500 are aimed at mildly bullish investors

By Emma Trincal

New York, May 13 – Credit Suisse AG, London Branch’s 0% digital buffered notes due May 29, 2018 linked to the S&P 500 index are designed to outperform in a slow growth market, said Tim Vile, structured product analyst at Future Value Consultants. They also offer some protection in a correction scenario.

If the final index level is greater than or equal to the initial index level, the payout at maturity will be par plus the fixed payment percentage, which is expected to be 13% to 15% and will 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 the 10% buffer and will be exposed to any losses beyond 10%.

Modest growth

“The fixed payout boosts the return if the index is slightly up. This is designed for investors who are not very bullish. A bullish investor would probably go for some leverage with a higher cap or, even better, little leverage and no cap,” he said.

The maximum return is fixed. As a hypothetical level Vile used the 14% mid-point, which would represent a 6.8% annualized return on a compounded basis.

“The index doesn’t have to go up by much,” he said.

In order for investors to capture the 6.8% annualized cap, the S&P 500 would only have to be up by slightly less than 5% a year.

“Given current market conditions, many investors would be happy with that 7% a year. Expectations are much lower among investors, and concerns are rising about a market downturn,” he added.

Investors who are not expecting much growth sometimes tend to be more risk-averse, he said. The 10% buffer is designed to address concerns about a market pullback.

“Investors in this note have limited growth expectations. They want market exposure, but they need the downside protection. The notes are structured defensively. The buffer preserves your principal on the first 10% loss. It’s a reasonable buffer for a two-year,” he said.

However, the notes showed more market risk than average for similar products, according to Future Value Consultants’ research report.

The notes fall into the digital product category.

Risk

Future Value Consultants in its research assesses risk, return and price using a variety of proprietary scores in order to compare a product to others.

Each product is rated against its peers – in this case, digital notes – but also against the “all-product type” category, which represents all recently rated notes across all types of structures.

The riskmap is Future Value Consultants’ score used to measure risk on a scale of zero to 10 with 10 as the highest level of risk possible.

The riskmap is defined as the sum of the two main risk components, market risk and credit risk.

The notes have a 2.29 market riskmap versus an average of 1.62 for the product type.

“It is a little bit surprising given the 10% buffer,” he said.

But the score is based on the comparison to similar products.

“It’s all a function of how easy it is to breach the barrier. It depends on the index, the volatility, the length of the notes, the type and level of downside protection, etc.”

On the other hand, the product showed a slightly better credit risk level of 0.43 versus 0.52 for the average digital product, according to the report.

Vile said the short term rather than the issuer’s credit was at the origin of the good score.

Adding market and credit risk components, the model generates a 2.72 riskmap, slightly above the average of 2.14 for similar products. But compared to all product types, which show an average riskmap of 4.29, the notes exhibit a lower level of risk.

“It’s not excessively more than average. There is risk, but the low credit risk help offsets the market risk,” he said.

This will help the risk-adjusted return profile of the product as measured by the return score on a scale of zero to 10.

Return score

The return score is calculated based on five key market assumptions: neutral assumption, bull and bear markets, and high- and low-volatility environments.

“With these notes, the best market assumption is low volatility. That’s because the market does not have to go up by a lot to give investors the maximum they can get. In fact, a one basis point increase will give you 14% in two years,” he said.

The return score is 7.03 versus an average of 6.83 for similar products and 6.40 for all products.

“Even though we have a slightly higher risk, we still get a reasonable amount of digital return,” he said.

“The fact that it’s a jump is also positive along with the guaranteed aspect of the return."

Value

For each product, Future Value Consultants 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.

At 7.44 the price score is lower than the 7.87 average for the digital category.

“It’s quite good considering that it’s a two-year product,” he said.

Shorter-dated notes indeed suffer on the price score scale. That’s because fees are calculated on an annualized basis. Therefore a short maturity will impair the price score given that the cost will be spread over a short period of time.

“I guess it would have been better if they had given investors a bit more than 6.8% a year. But it’s still reasonably priced. It’s a short duration, and you’re getting a 10% buffer down with a fixed gain for any increase in the index,” he said.

Overall score

With its overall score, Future Value Consultants offers its general assessment on the quality of a deal. The score is the average of the price score and the return score.

The notes have a 7.23 overall score while the average for the product type is 7.35.

“It’s not mind-blowing, but it’s still good. You get some downside protection and the ability to outperform in a range-bound market. The bump up in returns could be very valuable for investors who don’t see the S&P 500 rising much more in the next couple of years,” he said.

Credit Suisse Securities (USA) LLC is the agent.

The notes will price on May 20 and settle on May 27.

The Cusip number is 22548Q5M3.

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